A requiem for the Arab development model.

AuthorMalik, Adeel
PositionEconomics and Energy - Report

This article situates recent political turbulence in the Middle East within the long-term failure of the Arab development model that is based on economic controls and welfare concessions. After having sustained generous welfare entitlements for several decades, this development model is coming under increasing strains in the face of a growing and increasingly educated youth population, falling public spending, and an inflexible economic structure. Underpinning this failure is a weak and dependent private sector that survives largely through privileges rather than competition. This failure is most evident in the region's lab or-abundant economies, where privileges are concentrated amongst connected firms but employment is concentrated amongst small, informal sector firms operating at the margins of the economy. I argue that there is a deep trade-off between employment and autonomy; sustainable employment generation is not possible without giving greater autonomy to the private sector and releasing competitive space for its operation. However, private sector development is not simply a question of technocratic policy reform. In a context where economic controls generate rents for insiders and are used to sustain elite coalitions, development has to be conceived as part of a broader political concession.

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Few would dispute that the Arab Spring had clear economic underpinnings. Motivated by the demand for bread, jobs, and justice, the Arab uprisings reflected unmet social and economic aspirations of, among other things, a youthful population. In this article, I argue that the failure of the Arab state to deliver social justice is ultimately rooted in the failure of a development model based on heavy state intervention in the economy and increasingly unsustainable buyouts of local populations through generous welfare entitlements. (1) This "interventionist-redistributive" model of development--typically financed through external rent streams from aid, oil, and remittances--seems to have passed its expiration date. (2) Based on a social contract that trades political acquiescence for welfare distribution, it is primed to produce a failure of expectations. It compromises individual agency, crowds out the genuine private sector, and keeps systems of public finance underdeveloped. The Arab Spring was an indictment of this outdated development model.

Since gaining independence, Arab societies have pursued a development model that is structurally incapable of reconciling aspirations with opportunities. The twin pillars of this system--welfare provision for citizens and privileges for firms--are increasingly in conflict with aspirations for social mobility. While the system offers enough for subsistence, the mobility of both people and firms are restricted. This statist model of development has turned government into a provider of first and last resort, generating an adverse legacy of entitlements that ensures sustenance from cradle to the grave. While the system has expanded access to key entitlements, thereby raising levels of human development, it has trapped educated populations into unproductive jobs and kept social classes dependent and immobilized. With growing claims on state finances, it is no longer possible to accommodate an ever-growing pool of educated unemployed in the public sector. This is creating new "outsiders" to the system. These are the youth, women, and the unconnected, those lacking wasita, or connections, with government and private sector networks. (3) A major crisis of expectations is created for young people who are systematically incentivized to hunt for public sector jobs, turning them away from more competitive, low-wage, and high-effort employment in the private sector.

A similar insider-outsider logic operates in the private sector. If social welfare is maintained through a regime of provision, private economic activity depends on a regime of privileges that allocates economic opportunities through "closed deals" that are restricted to regime insiders. There are few growth opportunities for firms outside the inner circle. Business survives either when it is very close to the state, or very far away. This creates a lopsided distribution of firms, marked by large, politically connected firms at the top of the pyramid and small, informal sector firms at the bottom. As a result, the region suffers from the pathology of the "missing middle"--the absence of productive medium-sized firms that are crucial for job creation. Successful exporting firms that could extend the productive frontier are in similarly short supply. These weak firm dynamics mean that a miniscule portion of small firms graduate to become medium or large firms, having adverse implications for prosperity. (4)

The sustainability of this development model is being called into question by the rising costs of repression and redistribution. (5) Even countries that have traditionally had greater fiscal space to finance welfare provisions--thanks to their abundant resource endowments--are finding it hard to keep pace with growing expenditure commitments. At the current rate of increase in local energy demand, Saudi Arabia will find it very difficult to sustain its welfare regime; indeed, by 2028 energy demand is predicted to increase by 250 percent in Saudi Arabia. (6) Similar fears have recently prompted a Kuwaiti minister of finance to question the country's fiscal sustainability. (7) Rich Gulf states are not only financing the growing needs of their own restive populations, but are also financially supporting neighboring Arab states. For example, Saudi Arabia is effectively subsidizing the social contract of Egypt, Jordan, and Yemen. Without regular cash injections from Saudi Arabia and other Gulf neighbors, these countries will find it especially hard, if not impossible, to finance their generous subsidy regimes. It does not require clairvoyance to predict that this development model is ultimately going to unravel, since it is based on a costly and unsustainable social bargain.

This article summarizes the salient failures of the Arab development model, bringing into sharper focus the comparative role of the state and the private sector and the model's inherent contradictions. The underlying tensions are best reflected in the operation of education and labor markets. While central to explaining the region's long-term development trajectory, the discussion in this article may appear peripheral at a time of unusual turbulence, when the Arab world is passing through its most defining phase since the fall of the Ottoman Empire. Beset with growing violence and social upheaval, it is faced with existential questions that can challenge the very geopolitical make-up of the region.

This makes the focus on development more important, not less. A change in the geopolitics of the Arab world is unlikely to alter the core economic challenges facing the region. A thousand lines can be drawn in the sand to define one nation or another, but this will not alter fundamental economic realities. The issue of youth unemployment will remain, and so will the need to create a new social contract built on a vibrant private sector and a regionally connected market. Enduring peace can only return to the region if the political economy of violence is replaced with that of development.

The remainder of this article is organized as follows: Continuing the discussion on the Arab development model, section two attributes its endurance to the uninterrupted flow of external rent streams. Section three explores the contradictions of human development generated by this model. Finally, section four offers some reflections on shaping a more productive and just social order that better serves the needs of Arab societies.

THE ORIGINAL SIN (8)

A key tension point generated by the Arab development model is the growing mismatch between demography and economic structure. While demography is evolving, with its attendant challenges for labor markets and public services, the region's economic structure remains rigidly incapable of responding to these challenges. Most countries in the region have witnessed a very limited shift in economic structure. The manufacturing sector, which is a primary vehicle for job creation in emerging economies, has witnessed a slow, sometimes even negative, growth rate. (9) Whatever limited structural change the region has witnessed involves a shift from manufacturing to services (largely in government, retail, telecommunications, and banking sectors). (10) While such structural change has sometimes enhanced growth--as in Egypt, for example--productivity in the manufacturing sector itself is generally lower than the rest of the world. (11) With few exceptions, competitive manufacturing oriented towards global markets is largely absent. With the exception of Lebanon and Morocco, the Middle East and North Africa (MENA) region has fewer exporters than predicted for countries with comparative income and size. (12) The region also lacks large exporters that drive export growth and diversification. (13) Such feeble firm dynamics mean that few exporters are able to grow into large global exporters, and there is limited diversification by destinations or products.

In short, manufacturing remains the domain of old well-established actors. Excluding the members of the Gulf Cooperation Council (GCC), MENA countries have some of the lowest proportions of firms entering the formal sector. (14) This is exemplified by Egyptian firms. While politically connected firms in Egypt disproportionately benefit from energy subsidies and bank credit, they tend to operate in sectors that rely more intensively on capital than labor. Thus, despite benefiting from state patronage, these firms rarely act as the engines of employment creation. Evidence from a large sample of Egyptian firms in 2010 shows that politically-connected businesses accounted for...

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