Wednesday, July 23, 2014
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An Arab Marshall Plan

OXFORD – The wave of revolts that swept across the Arab world two years ago were fueled by demands for freedom, bread, and social justice. But, although the revolutions toppled dictators and transformed societies, these core objectives remain as distant as ever. In fact, the economic challenges facing the Arab Spring countries have become even more pressing, weighing heavily on these countries’ political prospects.

Unemployment has nearly doubled in Tunisia and Egypt, and foreign direct investment has dried up across the Arab world. Tourism revenues, while resilient, are declining, and fiscal challenges remain considerable. But the economic urgency is not reflected in the policy response, which has been painfully slow or non-existent.

For example, Egypt’s fiscal deficit will exceed 11% of GDP this year. But the country’s leaders have been stalling on the terms of a much-needed International Monetary Fund loan. The government’s reduction of fuel subsidies last year was not followed by additional reforms, and the required tax increase was delayed soon after President Mohamed Morsi announced it.

Almost all political stakeholders in Egypt, as in the other Arab countries in transition, recognize the need for economic reform. But neither citizens nor policymakers appear willing to bear its social and political costs. In a charged and uncertain political climate, in which new crises erupt on a daily basis, it is unsurprising that economic reform has been postponed repeatedly.

Politicians know that macroeconomic stabilization and social cohesion can be irreconcilable in the short run. Slashing food and energy subsidies in order to reduce fiscal strain is unlikely to win favor in a country like Egypt, where 40% of per capita income is allocated to food. Politics is thus constraining efforts to strengthen public finances. At the same time, narrow IMF prescriptions threaten to exacerbate political instability, with citizens no longer afraid to take to the streets to demonstrate their dissatisfaction.

The current impasse on economic reform highlights a larger point: subsidy and tax regimes cannot be reformed without first redefining the underlying social contract, which has long exchanged welfare distribution for political acquiescence. But such a move is far too risky for an individual politician, or even a single country, at a time of economic uncertainty and high unemployment.

In order to create the political space needed for economic reform, Arab leaders must underwrite a regional growth pact – a Marshall Plan of sorts – that would facilitate major new investments aimed at reviving economic activity. It is much easier to reform subsidy programs when the economy is expanding.

Moreover, building competitive markets is essential to ensuring sustainable GDP growth. To this end, regional trade barriers, which are more pervasive in the Arab world than even in Sub-Saharan Africa, must be dismantled. By agreeing to the pact, Arab countries would commit to reforming their subsidy systems and to reducing restrictions on cross-border economic exchange.

The regional dimension of prosperity has long been ignored in the Arab world. But weak regional linkages limit small firms’ growth potential, forcing them to depend on state patronage. Although Arab leaders often cite Turkey as a beacon of hope, they rarely acknowledge that the country’s recent transformation from the “sick man of Europe” to one of the world’s fastest-growing emerging markets would not have been possible had it not pursued regional synergies.

Such linkages are particularly important for Egypt and Tunisia, which will struggle to reduce unemployment unless Libya’s labor market – which has historically absorbed migrants from its North African neighbors – is reopened. And, while Tunisia’s situation seems to be the most promising, a crippling investment shortfall is threatening to derail reform efforts there. With Europe mired in crisis, capital flows from Tunisia’s resource-rich Arab neighbors are its best hope.

Furthermore, Arab countries must ratchet up development spending. Given that existing development banks in the region have largely failed to act as vehicles of coordination and commitment, a new institution – resembling the European Bank for Reconstruction and Development – would have to be established to oversee a regional aid push and underwrite the costs of economic transition. New investment vehicles, such as sovereign wealth funds and Islamic finance, can contribute financing to credit-starved firms.

At the same time, Arab countries must streamline current aid efforts. For too long, Arab governments have simply thrown money at problems, with the rich Gulf countries effectively subsidizing their troubled neighbors’ public services. Over the last two years, Saudi Arabia has provided more than $3 billion to Yemen. Qatar has provided  $5 billion to Egypt since 2011, with a promise of $3 billion more. And the United Arab Emirates recently pledged $2.5 billion to Bahrain. But unconditional aid only delays reforms, because it weakens budget constraints, which reduces pressure on policymakers and creates moral hazard.

The Arab Spring has exposed fault lines that run not just through individual countries, but also through the entire region. This calls for redefining relationships not only between citizens and states, but also among Arab countries. Above all, it is no longer prudent to divide Arab countries between donors and recipients, or between resource-rich and resource-poor countries. It is in the interest of the entire region – including those countries that do not seem to face an imminent threat of revolt – to contribute to their neighbors’ economic revival and facilitate their political transitions.

Read more from our "Revolutions on the Rocks" Focal Point.

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