Devin Stewart Interviews Marcus Noland on the Arab Economies

April 16, 2007

The Arab Economies in a Changing World

DEVIN STEWART: I'm Devin Stewart with the Carnegie Council's Global Policy Innovations Program. We also publish

I am here with Marcus Noland, Senior Fellow for the Peter Peterson Institute for International Economics. We just finished up a great talk on his newest book, Famine in North Korea.

I guess Marcus has no rest, never sleeps, because he is here to graciously talk about another project that he is working on and just about to be very productive and come out with a whole other product on a whole other subject.

The Institute of International Economics recently became the Peter Peterson Institute. Secretary Peterson was known for being very tuned in to demographics. I think he published Gray Dawn—is that correct?

MARCUS NOLAND: That's correct.

DEVIN STEWART: Why the name change? How did that come about? I'm sure a lot of people are wondering how it became the Peterson Institute.

MARCUS NOLAND: Well, Mr. Peterson was instrumental in the creation of the Institute for International Economics 25 years ago. This past year, on our 25th anniversary, Mr. Peterson made a very generous donation to the Institute, and we thought that it was appropriate, given his role as one of the founders, his chairmanship of the board of directors over the past quarter-century, and then this very generous personal financial donation that he made, that we rename the Institute in honor of him. So we went from being the Institute for International Economics to the Peter G. Peterson Institute for International Economics, or Peterson Institute for short.

DEVIN STEWART: Do you feel that the name change or the addition of the Peterson name will affect your mission at all?

MARCUS NOLAND: Well, I don't think it affects the core mission of the Institute. We remain the Peter G. Peterson Institute for International Economics. So we continue to do work across the panoply of international economics issues dealing with trade, finance, and, to a certain extent, economic development issues as well.

DEVIN STEWART: Marcus, tell me a little bit about your program, your sort of bailiwick.

Most of my time in the last few years has been spent working on a project with Howard Pack from the Wharton School at the University of Pennsylvania, producing a book which will be released later this month—at least it will be printed later this month; the formal launch may not be until early June—called Arab Economies in the Changing World. Howard and I have been working on this book for several years, and it should be released in the near future.

DEVIN STEWART: Wow! So from North Korea to Middle East.

Well, I'm the Axis of Evil guy.

DEVIN STEWART: Tell me about this book. It is coming out very shortly. You mentioned to me earlier that it was divided up into several very, very hot topics. Can you just give us an overview of the book?

MARCUS NOLAND: Sure. We argue that looking at the Middle East region as a whole, which we define as from Morocco in the west to Iraq in the east, that the principal challenge facing the region over the next decade or two is job creation. The demographics of the region are such that labor force growth is on the order of 3.5 percent a year. That is without increases in female labor force participation, which in fact has been rising. Given plausible assumptions about investment capital deepening and productivity, we calculate that the region as a whole will have to grow at a pretty steady rate of 5.5-6.0 percent a year over the next decade or so to absorb all that labor and create jobs.

Now, one of the principal ways that countries have rapidly expanded employment in the past is through a process of outward-oriented development. That allows countries to rapidly expand production in labor-intensive manufacturing or services sectors.

But the second driver that we identify in the book is globalization. Here the region's track record has not been good outside the petroleum sector. So while there is a demographic imperative to create jobs, one of the main ways that countries have done it in the past, through a successful process of globalization, is a question mark.

That uncertainty is deepened by the politics of the region, which combine in a unique fashion authoritarianism and political stability. So, while there is a kind of stability on the surface, we argue that these regimes may in fact be brittle and that there is a possibility for very abrupt political change. And as you know, the political opposition in most of these countries has an increasingly religious orientation.

So those things put together—a demographic imperative to create jobs, a questionable track record on globalization, and some deep uncertainty about political transitions—all work to create a very serious set of challenges for the region over the next decade or so.

DEVIN STEWART: It sounds like, in a sense, a big question mark, and I think that might be a sober way of describing it.

Are there any models in the world where such a combination has led to a positive outcome? In other words, are there authoritarian regimes that are indeed engaging with the world and economic relations, or a religious regime that might be a model to regimes in the Middle East that wish to tap into that growth engine for job creation?

MARCUS NOLAND: Well, obviously, authoritarianism per se is not a barrier to economic growth. South Korea and Taiwan in the 1960s and 1970s grew very rapidly under authoritarian governments, as does China today. So authoritarianism per se is not an insurmountable barrier to growth.

And there is nothing wrong with having religious values reflected in governance. In fact, it would be very surprising if they weren't. Here in the United States and in other countries, we have democratic politics in which people's religious values play a role in the determination of policy. So that's not any kind of barrier to economic growth.

The question is: What are the specific economic factors that constrain the countries in the Middle East today? We do take an explicitly comparative perspective in this book. We do draw upon the experiences not only of Asia, but the experiences of Eastern Europe and other regions in the world, to try to understand how the Middle East might successfully meet these challenges.

What we find is that the problems in the Middle East are largely microeconomic in nature. Macroeconomic policy is pretty good—there are not very high levels of inflation, there are not budget deficits that are out of control—but what we do identify are a nexus of microeconomic and institutional issues that seem to hamstring the region. Let me give you some examples.

It takes a long time to get contracts enforced. It takes a long time to start a business, and it is an expensive process. It is difficult for creditors to seize the assets of a bankrupt firm. So if you think of the life cycle of a firm—creation of the firm, operation of the firm, death and shutting down the firm—all of those things are relatively difficult in the Middle East. We argue that this is a barrier to entrepreneurship and economic dynamism.

Yet, at the same time, we find that there is a lot of intra-regional variation. For example, if one compares Egypt and Tunisia, it takes ten or twelve times as long to get a contract enforced in Egypt as it does in Tunisia. What that suggests is, on that issue and a whole variety of issues, simply achieving best practices, regionally defined, could result in significant improvement in economic performance. Egypt doesn't have to become Norway; just attaining the standard set by Jordan or the standard set by Tunisia in particular aspects of economic life could make a significant improvement.

What that tells us is the problems are not about Islam, the problems are not about Arab culture; the problems are rooted in a specific set of historical political practices and institutions.

DEVIN STEWART: Interesting.

Well, you talk about best practices for a region. How do best practices make their ways from this book into practice? Is your advice geared toward governments? Is it geared toward companies? Is it for what is perceived as a shallow civil society in some respects? What is the sort of transfer mechanism? What would be your first big piece of advice based on these findings?

Well, the message in some ways is a difficult one. We argue there are not any silver bullets. This is not a situation in which central bankers are being irresponsible and simply replacing the central banker or creating central bank independence or a new budget rule is going to solve the problem. These are problems that are not going to be solved by a small group of centrally placed technocrats.

It is going to be a real slog to change these microeconomic institutions and practices. And the particulars are going to vary from country to country, both in terms of what needs to be done and the political coalitions that will need to be created to get those reforms implemented.

One of the things you mentioned in your question was civil society. Outside the mosque, civil societies in these countries tend to relatively weak. A strengthening of the civil society sector is one of the things that is likely to both be necessary and accompany the sorts of microeconomic reforms that we see needed, because there is going to have to be grassroots support and implementation for many of these practices that are really determined at the grassroots level.

Do American corporate operators have an ethical duty to foment that strengthening; and, if so, how can they do so? How can American actors, corporate particularly, help out?

MARCUS NOLAND: That is a very difficult and sensitive question.

One of the things we discuss in the book is that, while we see the process of achieving the sorts of institutional changes and reforms in the Middle East as being protracted—as I said, a slog—with a lot of different people and different organizations making different sorts of moves and progress around the region in different sorts of ways, we see the American challenge in the region to be in some ways a similar long, protracted slog.

I think it goes without saying that the United States' reputation in the region today is in tatters, and simply pop music radio stations are not going to change that. The United States, we argue, is going to need to engage in a very serious and sincere process of engagement, not just at the government level, but at the corporate level, at the civil society level, in the Middle East to basically restore our reputation. This is going to require a long time and a lot of engagement to accomplish.

We argue that there are opportunities on the American side to do things, sort of like the old Amparts [phonetic] program that the USIA [United States Information Agency, 1953-1999] used to run, where nonofficial people were supported in coming to different countries and engaging with audiences, engaging with opinion makers, and so on, precisely because their nonofficial status gave them a kind of credibility that government officials don't have, and certainly don't have today in the Middle East. We have a whole variety of proposals in our book for how the United States could go about strengthening that.

One of those is that the United States needs to do a better job of using multilateral organizations, such as the World Bank, the IMF, the WTO, in this process. The reason is that in many of these situations the countries, for their own internal political reasons or leadership reasons or whatever, may not be ready to move forward. So, in effect, to make a financial analogy, what one is doing is buying an option on reform. That option may not hit its striking price for a long time, but you want to be there, you want to be on the ground, you want to have a local knowledge base, to be effective when things change and a country is ready to go forward.

We argue that institutions like the World Bank, as flawed as they may be, are actually very good for this purpose, especially in a situation where the U.S. government has such a bad reputation within the region at this point. These multilateral organizations may be able to engage in that kind of patient process of engagement, relatively de-politicized, technical advice and assistance, and actually may be very effective, at least relative to bilateral U.S. government initiatives, which, frankly speaking, are just running such an uphill battle, given public opinion in the region today, that we think the multilateral route should be a very important component of U.S. government strategy.

DEVIN STEWART: The multilateral route might be a way of legitimizing American actions, in a sense maybe diluting the perception of a heavy-handed approach. Could, in a sense, more activity and more engagement in the Middle East actually come back to bite us? Is there any sense to any degree at all that if the United States becomes more active, it might be seen to be meddling even further? I mean there are probably a lot of sensitivities about getting engaged further than we have already committed. Any risk on that side of the coin?

MARCUS NOLAND: Oh, absolutely there is a political risk. But there is also a very interesting situation that presents both risks and opportunities that we discuss in the book.

As you know, given the difficult situation that the world trading system is in, there has been an instinct or a new momentum to enter into bilateral or preferential trade agreements among different countries in the world. The Middle East is getting into that game. There are embryonic attempts to create free trade agreements within the region.

But we argue that, as well as free trade agreements within the region, really the things that could be of long-run economic significance are free trade agreements with the United States or with the European Union. Here those two partners present very different templates.

The European Union agreements for the countries of the Middle East are somewhat shallow. They do not put a lot of strong obligations on the part of either party. They tend not to cover things like services. There tend to be exclusions for sensitive products, such as agriculture, and so on. So it is a relatively low-cost and low-reward sort of engagement.

In contrast, the United States has a well-developed template for free trade agreements that are deep and in some ways intrusive. They cover things like services, investment, intellectual property, government procurement and corruption—all kinds of things. The choice that in some ways is facing the governments of the region is entering into an agreement with the United States is a kind of high-risk/high-reward proposition. On the one hand, it has obvious political risk. The United States is unpopular, and these agreements are, as I said, more intrusive in terms of the constraints and obligations they put on the signatory countries in terms of their domestic practices.

At the same time, if what you think is really needed is an improvement in domestic practices, then entering into an agreement with a large partner which is capable of demanding enforcement of these obligations may actually be a very useful pre-commitment mechanism. It says that, "not only are we now writing an intellectual property law, we are committing to it with the United States," which makes that law credible.

So, for example, in the case of Jordan, we saw a significant increase in technology licensing after the free trade agreement with the United States. Now, there are debates about how much of this stuff was under the table and was just brought to the surface, and so on and so forth, but I think it is fair to say that you can point to specific examples where a government making this commitment credible has generated a fairly rapid and significant response on the part of both local and foreign producers. So in the case of Jordan we see more technology licensing going on, we see more activity in some of those sectors that had been possibly constrained in the past by lax IPR [intellectual property rights] enforcement, and you can see real benefits.

But those are benefits that don't come without a kind of political cost to them. And so we see this as a kind of—it's not a cure-all, it's not a silver bullet, but one of a number of policies that the governments of the region may want to take into consideration when forming their economic plans.

DEVIN STEWART: Given the argument that this region, the Middle East, needs, I think you said, 5-6 percent growth to create enough jobs, do you see free trade agreements, bilateral or multilateral, one tool to achieve that type of growth?

MARCUS NOLAND: It's one tool, and they definitely have a role to play, but they are not a substitute for domestic reform.

Now, I should make clear that today, in April 2007, the region actually is growing pretty rapidly, a lot of that fueled by relative high prices of oil. There are two things that one ought to observe about that.

First of all, that rapid growth is not felt evenly across the region. Obviously, oil-producing countries are experiencing it the most, although there are positive spillovers, either through nationals from countries that don't have so much oil going to the oil-rich areas and working and sending home remittances, investment from the oil-rich areas going into some of the other countries of the region, and so on. It's not evenly spread across the region.

And we don't know if it is sustained or not. While the price of oil today is relatively high in historical terms, that's not to say that the price of oil tomorrow will look more like yesterday and not like how it looked for most of the past decade or two.

So I think it would be unfortunate or a mistake for countries in the region to bet social welfare policies on the maintenance of high oil prices. So when I say that they have to sustain 5 or 6 percent growth for the next decade or so, I mean sustain it. It's got to be there year in and year out in order to generate the degree of employment that is going to be necessary given the growth of the labor force.

There are many things that can go into achieving that. Free trade agreements are just one part of the puzzle.

DEVIN STEWART: Marcus, one last question. What is at stake here? I mean who should read this book, The Arab Economies in a Changing World?

MARCUS NOLAND: Well, obviously, the people most affected by developments in the region are the citizens of the region. They are the ones who suffer from relatively high levels of unemployment, relatively slow wage growth. Obvious social tensions and political tensions are created by a lack of voice and authoritarian governance.

One can imagine, if the economic problems are not resolved, that this results in a vicious circle in which political authoritarianism and instability deters investment, which slows growth, which simply creates more unemployment, which creates increasing social tensions, leading to even greater political repression, some of which may be manifested in political violence either internally or externally.

Alternatively, if these countries are able to surmount these obstacles, this demographic profile could go from a demographic time bomb to a demographic dividend. They will have relatively low dependency ratios, which is to say they will have most of their population in the prime working ages of their lives, and employment, rising wages, growth, could allow relaxation of political repression. A greater sense of achievement, self-consciousness, could contribute to greater social tolerance and liberalization. So what could be a self-reinforcing downward spiral could also be a self-reinforcing upward spiral.

I can't help but observe that the sorts of demographics that one observes today in the Middle East are similar to the sorts of demographics that East Asia has exhibited over the last forty years or so, a period that has been associated with both rising levels of material prosperity and increasing political liberty as well.

Admittedly, some of it has been of a kind of "two steps forward, one step back" character, but nevertheless I think it's fair to say that the region is entering a period in which the sheer range of possible outcomes is so wide that obviously it is of not only deep concern for those within the region but of great concern for people like you and me outside of it as well.

DEVIN STEWART: Thank you very much, Marcus Noland from the Peterson Institute. The book is The Arab Economies in a Changing World. Thanks very much.


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