Transcript of an IMF Economic Forum - Fulfilling a Promise: Reform Prospects in the MENA region
September 9, 2003
Washington DC, September 9, 2003
(View this Economic Forum using Windows Media Player.)
George T. Abed (Moderator), Director, Middle Eastern Department, IMF
Amer Bisat, Senior Economist and Portfolio Manager, UBS
Hani Findakly, Director, Clinton Group
Mustapha Kamel Nabli, Chief Economist and Director, Middle East/North Africa, The World Bank
Shibley Telhami, Professor, Department of Government and Politics, University of Maryland
MR. Starrels: Welcome to the sixth IMF Economic Forum of the year. We are delighted to have such a good turnout. Before turning over the floor to Mr. Abed, today's moderator, three housekeeping items. First, please avail yourself of the literature we have made available to you, which can be obtained at the entrance to the Auditorium.
Second, if you have a question or observation to make during the Question and Answer period, may we ask that you identify yourself by name and, if appropriate, institutional affiliation. Finally, these proceedings will be "on the record." On these notes, Mr. Abed, the floor is now yours.
MR. Abed: Within the IMF, the Middle East and North Africa region consists of 24 countries with Pakistan bordering the region on the east all the way to Morocco and Mauritania on the west, and most of the countries in between.
The region obviously is diverse. It has small countries, large countries, rich and poor, advanced and developing. To try to generalize about the region is sometimes hazardous, and one should be careful not to carry the generalizations too far.
However, the region does face common challenges--some of which are typical of emerging economies and developing countries; others are somewhat specific to the region.
If we look at the structure of the economies in the region, we find perhaps two or three distinguishing characteristics that may be worth pointing out. One is that a number of countries depend on oil exports to sustain their development and the financing of their budgets and needs. We also find a group of other countries that have a legacy of centralized planning and state control. And in both cases, we find that a good deal of the revenue of the state accrues from what we call economic rent, whether it be oil income, foreign aid, strategic location, to some extent remittances, although they're not strictly economic rent, and other sources of revenue that sustain large state structures and public sectors that are often inefficient.
In part because of the structure of these economies, but also, I am sure, for other reasons about which you will hear later this afternoon, the economic performance of the region has been mediocre in the past 20 years.
If you take the region from early 1980, when oil prices peaked and then went on the decline, until about 1999, we see that the oil-exporting countries experienced a net decline in real per capita income, in part because of the decline in oil prices, sluggishness in the oil markets, but also because of population increases, which were rather high by international standards.
The non-oil economies did somewhat better, but the growth rate remained mediocre and insufficient to address the mounting unemployment problem, which at this stage, especially in the larger countries, remains in the double digits.
Now, the region also has avoided major economic or financial crises, but while doing so through macroeconomic stabilization and defensive measures such as accumulation of reserves, maintaining to some extent macroeconomic stability in the financial and the fiscal areas, they have also restrained the potential for much higher rates of growth. And the region, in fact, may be characterized as one that is in a state of low-growth equilibrium or a low-growth path.
The factors that go into explaining this malaise, as some have termed it, are many and have been discussed widely. They have to do with the role of the state and the size of the public sector, the weak financial sectors, the unreformed fiscal systems, trade restrictiveness, and the rigidity of exchange rate regimes.
Now, of course, not all is bleak in the region. In the late 1980s, the region experienced very slow growth and some decline in per capita incomes that forced governments to undertake reforms, and a number of reforms were introduced, including in the fiscal area, such as the introduction of VATs, some improvement in public expenditure, some trade liberalization, and some attempts at other macroeconomic reforms, and beginnings of some structural reforms. This took these countries forward to about the mid- to late 1990s, but then the reform momentum waned and we see, in fact, a decline in economic performance in the last five or six years.
Nonetheless, reforms have been undertaken in a number of countries. These have been mainly in the financial sector, such as improved supervision in banks, improved monetary policy frameworks, liberalization of interest rates, and, to some extent, introduction of greater flexibility in exchange rates.
In the fiscal area, some improvements in the tax system have been undertaken, as I mentioned, by broadening the tax and introduction of consumption-based tax, such as VATs and generalized sales tax.
Privatization has been undertaken in a number of countries, but much of that dealt with the privatization of those entities that were easier to privatize, such as telecommunications. Deep and strategic privatization is yet to be completed.
Other reforms were also undertaken in the area of the regulatory environment and improvement in business climate, although, again, the progress here is halting and not very deep.
The question that we want to address this afternoon with our distinguished speakers--and I will introduce them in a minute--with these reforms that have been undertaken and the progress, to some extent, made by some of the countries, especially, the countries in the Gulf Cooperation Council, some countries in North Africa, countries such as Jordan and Tunisia, and recently Pakistan, can we expect this region to reform itself in such a way so as to achieve much higher rates of growth on a sustainable basis? Is the region, especially with the attention of the world community now focused on Iraq, on the Palestinian-Israeli conflict, on the repercussions and implications of the intervention in Iraq to the region, is it on the verge or on the threshold of major changes that could bring about greater prosperity and higher rates of sustainable growth? Or is the region in a state of tense anticipation and, depending on what happens in Iraq and in Israel, Palestine, it could go into a period of stagnation?
To address these questions, we have assembled four distinguished speakers who will cover different aspects of this question and other issues related to the economic prospects of the Middle East-North Africa Region.
Let me first, before I introduce our distinguished speakers, lay out some of the challenges that we are all facing in dealing with the prospects for the Middle East. There is first and foremost the question of the growth challenge. In other words, how can the region reignite and sustain high output and productivity growth? What are the key potential sources of growth and how to secure these in the immediate period ahead?
The flip side of growth, of course, is the employment question, as I alluded to earlier. And on employment, what types of reforms will be needed in labor markets or in the economy to generate a sufficient number of new job opportunities commensurate with the existing demand for labor?
The question of the integration of the region into the global economy: How can the Middle East-North Africa Region integrate better or more effectively with the world economy so that it can benefit from world economic integration and from globalization more generally?
The question of institutions and governance: How can the region improve its institutions, the institutions of state, as well as the systems of governance, transparency, and accountability, so as to begin to realize the gains from a more open environment and more market-based development?
And, finally, the question of the political challenges that lay ahead: What set of political reforms are needed to lay the groundwork for meaningful economic reforms? There are those who say that in the absence of political reforms, it is difficult to see how economic reforms can go very far in the Middle East Region, like in any other region. And what are the prospects for such political reforms in the MENA Region?
With these issues and questions, I would like first to call on Dr. Mustapha Nabli, who is the chief economist of the MENA Region at the World Bank. Let me introduce at this point also our other speakers, our distinguished speakers: Professor Shibley Telhami of the University of Maryland and senior fellow at the Brookings Institution; Dr. Hani Findakly, who is Vice Chairman of the Clinton Group, an investment management group here in Washington, and previously with the World Bank and previously in New York, again, in the area of investment management and financial market and private sector development; and Amer Bisat, who, as you'll recall, was one of our own in the Middle Eastern Department until a few years ago, when he jointed the financial markets, and now is with UBS managing a hedge fund.
With this introduction, I would like to begin with Dr. Mustapha Nabli to give us his views on the question of governance, institutions, and the growth prospects or development prospects of the Middle East-North Africa Region. Mustapha?
MR. NABLI: Thank you, George. And thanks again for this opportunity, and I hope we have a good discussion. It's promising.
Let me start by saying that whoever said that the IMF and the Bank are in the same bag don't know what they are talking about, because it happens that how the IMF defines the MENA Region is not the way the Bank defines it. So the MENA that I am going to talk about is the one that stops in Iran. It does not go to Pakistan. And also it's different in the South, but broadly speaking, I think we are talking about the same countries and the same issues.
Let me try to step a little bit back and start with a bit of history, and my history is going to start with the 1980s--not very far, it's not a big history, but I think it's instructive because I think it helps us to understand a lot what's happening today if we understand what has happened in the 1980s and the 1990s.
We all know that the 1980s, the mid-1980s, were a crisis situation for the region with the collapse of oil prices, and the model of development that was prevailing was running into difficulties which were brought into force much more than otherwise with the collapse of the oil prices.
You all know about the crisis, so I am not going to go into that detail and so on. I think it hit almost every country in the region. But we know also what the response was, and, actually, there was a strong response by the countries of the region throughout. I think one cannot say that there was no response, there were no efforts to deal with the issues. Actually, if you look at almost every country, there was a strong policy response.
The response first was at the macroeconomic level, and I think overall when you look at the IMF work and so on, fairly successful on the macroeconomic side. Most of the countries have, with maybe one exception or so, you have, you know, more or less good macroeconomic frameworks in place, debt levels, in terms of inflation, in terms of budget deficits, and so on. There is still some problem at the exchange rate level. Some countries are still sticking to the fixed exchange rate levels, which are not helping much. But also even on the exchange rate level, there has been quite a bit of movement, and many countries have moved into more flexible exchange rates to preserve their competitiveness. So, overall, I would say successful on the macro framework, on the macro front.
There was also quite a bit of effort at the structural level, and George indicated a number of those areas. I will not go into that. Initiation of lots of reforms, you know, different areas, from, you know, reforming investment climate issues to financial sector to fiscal reforms and so on and so on, trade and so on.
But, overall, when we look back, you know, from the mid-1980s to now and we compare with the rest of the world, the structural reform agenda has not gone very far, actually. If you compare even the most successful compared to what's happening in the rest of the world, the reform agenda has been in general weak, often hesitant, and in some cases even reversed. So I think that's the big--I mean, that's the lessons I draw from the experience of the 1980s and 1990s.
Now, what I would like to do is ask why. How can one explain, you know, success on the macro front and limited progress on the structural front? And for that I would say there are two main reasons.
The first is that while the oil price shock of the 1980s was big and reduced the resources available, the rents that George was talking about, there continued to be relatively soft, in quotes, soft budget constraints in the countries of the region. There continued to be significant access to resources which are rents or quasi-rents or what I would say--usually I like to say, call it easy money or money that it not domestically produced wealth, that doesn't come from domestically produced wealth, including remittances, actually. That would fit that definition.
So oil resources declined. Aid, you know, declined in the long term, but there were fluctuations. And remittances were increasing enough so that values were declining in per capita terms.
However, they remained to be significant, and when I look at those numbers, they are quite high. They're a significant share of GDP of the region. Actually, they're not very far from what you see in Sub-Saharan Africa, and even higher. So there continued to be access to soft budget constraints which allowed most governments to continue with the welfare systems that exist and did not need--at least they could afford not to move forward with the reforms that would be creating more domestic wealth. So that's the first reason, I would think, that it was possible to postpone, whenever possible, the reforms that were needed. And countries were not running into new crisis, as was said, and the isolation from the financial markets and so on, you know, allowed this to continue.
But the second most important reason that I would like to emphasize is that this situation essentially has a lot to do with governance, and at the root of the problem are governance issues. Governance, which I will not be able to go very much into, I would just like to refer you to just released yesterday a report from the Bank on this issue, which is called "Better Governance for Development in the Middle East and North Africa," which goes into this issue of governance and how it is critical to understanding the issues of MENA today and the prospects in the future.
Actually, this--just I open a parenthesis here. This is part of a series of reports that the Bank is putting forward on the occasion of the Annual Meetings in Dubai, which are four reports, actually: one on trade and investment which came out a couple of months ago, and we have the governance report that just came out yesterday, and coming out in the next couple of weeks as we move toward Dubai, one on employment and one on gender issues, gender and development issues, which we think are part and parcel of the development agenda and the issues we are talking about today.
Governance, I think, explains--you know, helps understand the situation because what it means is that reforms that were easily taken by top-down measures, you know, stroke-of-the-pen kinds of measures, are easily taken and implemented. You can reform the exchange rate, you know, fairly easily. You can reform, you know, the monetary policy relatively easily. It has political implications and so on, but in terms of getting there and getting the decision made and implemented, it is relatively simple. So that explains why the macro framework was, you know, brought into control, and there are other factors, clearly, but understand that. And why a number of other policies were easy to implement because they were stroke of the pen. For instance, when you reduce tariffs, you know, from 100 percent to 50 percent, that's really easy because you don't really jeopardize the existing protection system, you know, because you have a lot of slack so you can do it and it's not a big deal.
However, when it came to the more substantive reforms, which really touched the interest of many groups, whether it's financial sector or whether it's really bringing down trade tariffs, you know, to a much lower level than what they are, in the 20s, and bringing them to 10 percent or so on, whether you are talking about implementing actually fiscal policy that, you know--and do really collect the income, whether you dismantle the subsidies, you know, that are going to the private sector in terms of distortionary investment policy and so on, that's much more difficult. And it has to do with the process, and that's where governance comes. Decisions are made and consensus building is made and implementation of these policies is possible or not.
And here we see that, you know, that's why it was not possible to go forward because the system--the political system and the economic system in place were not able--given the nature of the political system, they were not able to move forward much faster and they were stuck at that level of reforms.
So that's my first point really about, you know, trying to understand what happened in the 1980s and what are the reasons for that, and it brings me to the centrality of the governance issues in all of this, and which means that the centrality of governance for the future. Again, I will come back to this in a moment.
So let me go to my second point and talk about it now. So that's really going back to the history and trying to understand a little bit what was happening.
What's happening now, I think, is a question of whether we are in the middle of a new crisis, potentially, that is not visible, and let me say why. I think there may be, you know, the roots of some kind of crisis that is brewing in the region and that we have to be aware of.
The first factor for that is the fact that the soft budget constraint that I was talking about is tightening. The resources that we are talking about, we have been talking about, are much less than what they were even 15 years ago. When you look at the oil rent per capita, it continues to fall on average in the region. When you look at remittances per capita, they continue to fall. When you look at aid per capita, it continues to fall.
So the resources that were available to sustain the old model are eroded, are being eroded increasingly, and I think the best example for that is when you look at Saudi Arabia and you look at, you know, the oil rent per capita in Saudi Arabia. It's very striking, but it applies almost everywhere. So it means that what has been helping sustain the old system is being undermined. So that's one.
The second issue, which is much more important, is the internal dynamics of the labor markets, and we go at length at this in this, you know, report, which is not still out yet, but I just want to give you a flavor of it.
What's happening is that MENA is undergoing one of the most dramatic, you know, episodes of labor force growth ever seen in history. When you compare labor force growth--by the way, I talk about labor force growth and not population growth, because many people think that population growth is still high in MENA. The population growth is not high anymore in MENA. On average, the growth rate of the population is on the order of 2 percent, and it's falling very rapidly. However, labor force growth continues to be very high, and MENA has known labor force growth higher than 3 percent for the last 30 years and will continue over the next 20 years to know such high rates, which will run from 3.5 to 3 percent. And a sustained period of 40 to 50 years of higher than 3 percent labor force growth has not been seen anywhere in the past. Whether you look at East Asia or Latin America or whatever, you don't see that.
So the pressure that is building, the momentum of the labor force growth is dramatic. And what is interesting about it, it has two sides to it. One is that this labor force growth is coming to a large extent from the female side. The female labor force growth is dramatic. It's on the order of 5 percent or more, and, second, it's essentially youth, educated labor force growth. So it's young people who are increasingly educated. If you look at the last 30 years, dramatic increase in the average years of schooling in the region, not seen anywhere else in the world. We have looked again and again at the numbers. The average years of schooling in the region have gone from less than one year of schooling in '60 to about 5.3 or 5.5 now. Dramatic increase. For females it has gone from less than 0.5 year to about 4.5 years of schooling or more now. This is '99, so by now it should be higher. And it's increasing very rapidly. So increasingly educated labor force, young, female, that is coming on the labor market.
Clearly, what is very important is that the growth rate that has been seen has been sluggish and has not allowed this labor force to be employed. So, therefore, what you see is the dramatic increase over the last two decades of unemployment rates, which have almost doubled in the last 20 years, and they continue to rise. The average unemployment rate now in the region is about 15 percent. It varies a lot. It goes from, you know--depending on measurements, clearly you know the issues of measurement, but even from the measurements, they go from 30 percent to 8 or 9 in some countries and so on. But the main issue is that it's mostly rising and will continue--some projections show that it will continue to be rising in the foreseeable future.
So the declining resources, rents, the building of pressures in the labor markets, you know, high labor force growth, high unemployment, almost stagnant or declining real wages, are meaning that the labor market pressures are becoming untenable. And, therefore, something has to happen, and that's why I'm saying whether we are having some crisis brewing in there.
My main point here, to conclude, since I have a couple of minutes, is to make two points.
One is that facing this challenge of the labor markets, with all the aspirations of it--I am not talking about, you know, the information age and the aspirations of this young, educated, and increasingly female labor force and population with increased aspirations and so on. All of this means that the demands are extremely high for a change in the model to allow the model to deliver better outcomes in the labor markets and growth outcomes. And this agenda for reform, which I will not have time to talk about, cannot be partial, cannot be hesitant, cannot be piecemeal. It is no more the time to do small, you know, reform here and small reform--it's really--it has got to be sufficiently comprehensive with a minimum kind of scope and minimum momentum for things to change fundamentally.
Which brings me to my second point, that for this to happen the governance systems have also to adapt, to be able to deliver this change that is needed, because these packages of reform cannot be done top-down, piecemeal, as they used to be. They can only be made if you have different governance systems, different processes of getting decisions to be made and the decisions to be implemented, and for people to be accountable for these decisions. So unless that happens, the prospects for the major changes that need to take place to happen in terms of the economic reform program and the policies towards more integration in the world economy, all the things that we all know about, is unlikely to be happening.
I will stop at this point.
MR. Abed: Thank you very much, Mustapha. I think you raise some very interesting and provocative, I would say, points about the demise of the state-managed paradigm of the economies in the region and the importance of institutions and governance to help navigate through the forthcoming changes and reforms which are likely to be fundamental, deep going, and comprehensive.
As we see the demise of the state-led development paradigm in the region, the question arises: Would the private sector pick up the slack and begin to replace public sector activity to generate the kind of investment growth and job creation that is needed? And on this question and other related questions of the role of the private sector in the MENA Region, I turn to Hani Findakly, who will share with us his thoughts on this issue.
MR. FINDAKLY: Thanks very much, George, and thank you for inviting me. And I want to commend really the IMF for holding these kinds of forums to allow the exchange of views and information on this topic, because it's through these kinds of forums that ideas can get debated, tested, and probably incorporated into policies.
Is there an alternative to the public sector? Let me start out by telling a story. The story is about a man in the Middle East who was walking on the side of a high mountain, and he slips and starts falling. And in his desperation, he holds onto an object and finds out it's a tree stump. And he is catching his breath, and he looks down and he sees a thousand feet of rocks behind him. And he turns religious, being from the Middle East, and he looks up to the sky, and he says, "Is there anybody up there?" And to his amazement, a voice comes back from the sky and says, "Yes, son, there is somebody up there." And the man says, "Well, all right, then, please help me." And the voice came back and says, "I will help you, but, first, do you believe?" And the man looked down, looked up, "Of course, I believe. Are you kidding?"
The voice came back and he said, "All right. If you believe, let go." The man now is totally desperate, looks up to the sky, and he says, "Is there anybody else up there?"
MR. FINDAKLY: That really in 30 seconds sums up the dilemma that faces the region and that system of dependency that has prevailed in the region for quite some time.
I recently spoke about the yoke of the three dependencies that characterize the region, and I will talk about those three dependencies very quickly and then move on to talk about how you get from under that yoke into the alternative, the other person in the sky.
Dr. Nabli spoke eloquently about the dominance of the public sector and its role in the region. Something like 30 to 35 percent of GDP in the region is coming from central government expenditures. Something like 30 or 35 percent of wages come from the public sector. And the public sector in general, you know, can perform some very important services, except that it dominates most of the economic activities of the region.
The most critical problem that it has, apart from all the stuff that's discussed--the lack of transparency, the lack of efficiency, the moral hazards involved--is really the absence of competitiveness, the absence of competition. It is the absence of competition that reduces efficiency, that slows down the process of economic activities and production and growth and job creation in the region.
The second dependency that also has been discussed--and very well done in a booklet that the IMF recently did, which I read and I was very impressed with and I recommend it to all of you--is this dependency on raw material and in the oil-producing countries on energy products and oil.
Apart from the obvious concentration of risk, putting all of your eggs in one basket type issues, and apart from the fact that oil prices, as we all know, are volatile and that volatility transmits itself very quickly into the economy, into government expenditures and what have you, is a lesser known fact, and that is the decline in the value of raw materials and energy products, the relative decline of those products overall to skills and to know-how. Just think about a basic product, which is copper, that is used basically for transmitting signals on cables, electrical signals; fiber optic, that's made out of sand, would require about one pound of silica, of sand, to transmit the same signals as a ton of copper would produce.
What happened over the course of the last five, six, seven decades is a major decline in the value of raw materials to know-how and skills, to the tune of about 95 percent. In the case of oil, slightly lower, it's about 50 percent, relative decline in the value of energy products to skills. That explains very well, I think, the kind of stagnation and lack of economic growth particularly in the Middle East because of this very heavy dependency on that.
The third dependency is the dependency on lower-skilled wages, which is very much related to that second point. Something like about 30 percent of the workforce in the region is engaged in agriculture and rural activities that produce only about 14 percent of GDP. Another 40 to 50 percent of the workforce in the region is engaged in relatively low-level, low-skilled activities that generate between 50 and 75 percent lesser wages than comparable manufacturing and services jobs in the region, and something like 90 percent below wages, comparable wages, in the industrial countries. That explains the lack of wealth and lack of income and lack of job growth.
Now, short of any kind of Malthusian shock to the region over the next 30 or 40 years, the real challenge for the region is not only to employ its existing workforce, but the growing labor force that Dr. Nabli spoke about, 3, 3.5 percent, and I understand that there's no comparable historical experience of this type in the world.
So where do we go from here, and how do we go about creating jobs? I started out thinking about this by looking at the experience right here in our backyard in the United States, and while it's not reasonable to expect a comparison between the U.S. economy and the economies of emerging markets in the Middle East, I can tell you there is some real relevance. The real relevance is the restructuring that took place in the U.S. economy here over the last 20 or 25 years.
Today, something like 52 or 53 percent of the U.S. GDP is produced by small businesses that employ 50 people or less. Over half of the labor force in the United States works for those small businesses. Surprisingly, over half of exports of goods and services are now produced by those small businesses.
If we can take a lesson from that and move towards the experience of the countries in the region, where there is an enormous amount of capital, a savings rate that's extremely high, an enormous amount of wealth and capital that's there, part of it is locked in the region. That capital is not utilized. Part of it has been basically exported to support the economies of Europe and the United States and elsewhere. That capital, whether it's from the oil-rich countries or from even the poor countries, where flight capital is equally large, can be redeployed in the form--or at least partially redeployed in the form of risk capital.
Quite a bit of the reform that we've spoken about and have heard about earlier from Dr. Nabli, including the issue of privatization, has stalled, and it has stalled for a whole bunch of reasons. Some of them have nothing to do with the intent of reform, but part of the problem with the privatization and the devolution of these public enterprises into private hands is the fact that privatization in the early stages creates a higher unemployment rate, creates--basically laying off workers who are no longer needed in these entities.
A real challenge for government--no government will take the kind of risk that will induce additional social pressure by creating higher unemployment in the hope that better performance will come down the road. So higher unemployment in a way creates a vicious circle that slows down the reform process. That creates higher unemployment, and you need to break that deadlock.
That's why I believe that the experience of creating the enabling environment for job creation at small levels is one that probably will go a long way to solving the region's most complex problem, which is the job creation, by first allowing those small entities to grow and prosper, without threatening the major interests in the region. At the same time, it allows for that labor force to get absorbed while the governments pursue other pieces of reform.
I will stop there, but I will tell you that in order for those kind of conditions to prevail is a range of enabling conditions that need to be implemented. The two key points of which are property rights and the legal system that needs to enable companies and businesses to operate, where there's an adjudication of conflicts and enforcement of shareholders' rights and bankruptcy laws in the country.
Thank you very much.
MR. Abed: Thank you, Hani.
And with this insight into the role of the private sector, potential role of the private sector in the MENA Region, I turn to Mr. Amer Bisat to give us his thoughts on the role of the financial sector in channeling savings into investment and improving the performance of these economies through more effective mechanisms for financial deepening and diversification of assets.
MR. Bisat: Thank you very much. Thank you for inviting me. It's always a pleasure, as a personal note, to be invited back to the Fund to be among very close friends.
What I wanted to do today was to essentially focus my remarks on the financial globalization angle of MENA's unfulfilled promise. By any metric, essentially, the region is remarkably isolated from the global capital markets. Just consider the numbers.
Since the mid-1990s, when the emerging markets finance as a phenomenon started, roughly $1.5 trillion worth of capital flowed into developing countries. Of that total, less than 5 percent came to the MENA Region.
Of the FDI component of that total, also 5 percent went to the region. Even more striking when you look at debt-creating flows, only 1 percent of debt-creating flows by the market, what we call market-based lending, went to the region.
The moral of these numbers is fairly straightforward. It essentially says that the region is incredibly isolated financially and not even on the radar screen of the New York and the London financiers. So obviously the logical question here is: Why is it that that is the case?
What I've done in the last couple of weeks, knowing that I was coming here, was to actually pick up the phone and speak with a number of those bankers, the ones who actually have the relationship with the Middle East, and ask them essentially why is this state of isolationism. Obviously, the corollary question becomes what to do about it. And I wanted to group their answers into four themes.
For one thing, almost all of them spoke of economic malaise as a hindrance to capital flows into the region. Now, at the end of the day, capital flows to where there is economic dynamism, to where there is a high rate of return. At the corporate level, that's high earnings. At the national level, that's economic growth. And there's no reason for me to repeat what has been said much more articulately by George and Dr. Nabli about the growth challenge of the region.
The second theme for the absence of international capital, according to those bankers, is that the region has not offered a trigger, an impetus. Now, what does that mean? Essentially, the experience of most other countries, most other regions, is that capital often flows after a trigger, some sort of an impetus that effectively develops a relationship between capital markets and the countries; something that breaks information failures. Structural transformations, including privatization, tend to be usually the most powerful or the most typical trigger, the most typical impetus.
The region had its share of triggers early in the 1990s: the privatization programs in Jordan, in Egypt, in North Africa. We also more broadly had regionwide periods of trade liberalization and domestic financial sector deepening, which created sort of exciting episodes of structural--of corporate restructurings. And that invited a number of international banks into the region; sort of the jet-setting international bankers became a fixture of (?) Mansur(?). Wherever you go, you used to see them in their suits.
Since then, though, unfortunately, that reform process appears to have come to a screeching halt, and with it the exodus of the bankers and the exodus of international capital.
The third sort of explanation had to do with what we polite economists refer to as institutional transparency, but you talk to these less polite bankers, and they speak of inefficient legal systems. They speak of overstaffed bureaucracies, of politicized regulatory regimes, and, of course, of corruption. And those to their minds are important structural hindrances for the attraction of capital into the region. And finally, and probably not least important, is politics, broadly defined.
Let me admit here that talking to the bankers, I felt that they exaggerated the role of politics in the region. Bankers tend to be too influenced by headlines and by stereotypes. But, nonetheless, security concerns are issues, and the region is undergoing massive sociopolitical changes that introduce uncertainties, and bankers are an extremely paranoid group of people. They do not like uncertainties at all.
Now, obviously, the moral here is that the region is financially isolated and there are very complicated reasons for why this is the case. Obviously, the second question is: Is that bad? Is it bad that the region is financially isolated?
Now, until recently, most mainstream economists, including myself, would have answered the question with an emphatic, "Yes, that is bad. The region should be financially integrated in the capital markets." The argument was straightforward. Capital would increase what is otherwise an incredibly low investment rate or low investment rates. It would increase the frustratingly low levels of total (?) productivity of capital and will augment what is otherwise a modest level or a relatively low level of national savings in the region.
So the combination of these three things--higher investment, higher productivity, and higher savings--would have contributed, the argument went, to higher growth. So that was something--it was a Holy Grail that we all looked to.
A decade after this mainstream view was created, is the conclusion still valid? Now, unfortunately, I'm not sure anymore. We've had multiple emerging market crises, and those have caused a series of self-introspection. Many, including myself, now feel that globalization should actually come with a surgeon's warning to the effect that this may be hazardous to your health unless you are very well prepared.
That sort of brings me to a very interesting paper that was written at the Fund itself that contributed to this self-introspection, the paper by Rogoff and Prasad, which I thought was a very interesting paper. It did not dismiss the importance of financial integration, but what it did is that it said the countries better be well prepared before they can actually reap the benefits of global capital. Indeed, the paper, I thought, was very honest in saying that if the country is not well prepared, the converse could actually occur. You could have increased vulnerabilities, and you could actually have -- [tape ends].
T1B -- back to the question of the region. Does the region meet this threshold of readiness that Rogoff speaks about? And the case is far from clear, to my mind.
The macro house of the region may not be ready for intensive episodes of capital inflows, particularly as it relates to the exchange rate regimes chosen by most of the economies. Most would agree that fiscal vulnerabilities are not ready at all. Institutions, broadly defined, remain weak and may be well overwhelmed by any surge of international capital. And, finally, the domestic financial sector is probably ill prepared to intermediate large surges of flows.
Which sort of brings me to my final point. Most if not all of recent emerging market crises have banking sector components to them. In particular, we've had excessive foreign capital inflows that overwhelmed the domestic banking sector. And essentially, as flows reversed, the domestic financial sector fell under the weight of very large non-performing loans.
In fact, it would now appear that the traditional recipe of domestic financial sector reforms is no longer sufficient to prepare the banking sector. Interest rate liberalization, removal of debt lending, privatization of domestic banks are all very important reforms, but by themselves may not be prepared, may be not sufficient to prepare the banking sector to intermediate properly foreign flows.
By all indications, including a paper that was recently put by the Middle East Department in the pamphlet that is outside, the financial sector of the region has actually done relatively well measured by the traditional menu of domestic financial sector reforms. Those, I suggest, however, are not enough. A second generation of reform in the financial sector is actually needed before the region allows more intensive capital account liberalization.
More is needed in terms of strengthening regulation, development of money markets, building non-bank financial institutions, developing a modern legal framework, including for bankruptcies, strengthening risk controls, and perhaps most importantly, weaning the sector from being excessively dependent on the public sector, including lending to it.
So if I'm allowed to summarize, I think I tried to make five points. The region is not on anybody's radar screen in London or in New York. There are very important and complicated reasons for why this is the case: macro, structure, and political. Contrary to the mainstream view that I think was prevalent a decade ago, it's not clear to me that the region may be ready now for financial integration.
The corollary to this argument--and this is probably the most important point I want to raise today--is that the reform policy push in the region should prioritize the domestic reform agenda first before getting on to the more risky one of deepening international integration.
And, finally, there is an ambitious subset of reforms that are needed to prepare the domestic financial sector for a truly open capital account.
MR. Abed: Thank you very much, Amer.
Before we move to our next speaker, it is clear that while the region or the region's countries have undertaken reforms in a number of areas, the theme keeps coming up that these reforms have not gone deep enough, have not caused fundamental changes in the structure of these economies and societies; and the question of governance and institutions keeps coming up as major areas for reform.
In this context, then, with the state structure being dependent on operating [under] a soft budget constraint, or as we say, dependent on economic rent to enhance and enlarge its influence, to bribe potential detractors by appealing to their vested interests in maintaining the economic status quo, and to continue to perpetuate itself has--maybe these various factors explain the regions' low growth rate.
As the region gets the attention that it is now getting from international financial communities, especially in Dubai and elsewhere, and as the spotlight is on Iraq, on other parts of the region, the pressure coming from external sources for reform, as these pressures increase, do we expect the state structures to react in a positive way to accelerate and deepen reforms and, therefore, to bring about the needed prosperity in the region? Or are the state structures themselves going to recoil and resist change, continue to shepherd the status quo, and, therefore, continue with this economic malaise that's been described by the speakers?
Therefore, the question of political reform becomes essential when we try to get deeper into the question of economic reforms, and on this issue, I would like to call on my friend and colleague Shibley Telhami, professor at the University of Maryland and, as I said, senior fellow at Brookings, to reflect on political economy issues, or the politics of reform in the MENA Region.
MR. TELHAMI: Thanks very much. I really appreciate being on this platform. Usually I agree to speak when either I want to be heard or when I want to hear, and this is a case where I want to hear. And I've learned a lot already on the economic issues.
I do bring in the political perspective on this issue, which really cannot be disentangled from the economic. I think it is clear from what we heard that it is not that difficult to come up with prescriptions as to what needs to be done at the economic level and to see what the problems are: the labor market issue, the need for legal reform, the need for skill development--all of those things that are essential for a serious economic reform program in the Middle East.
The real issue is: Are they likely to happen? And how will governments react to it? How do you get governments to adopt these programs? And that's really ultimately a much more political question than it is an economic question.
As a political scientist, I always start with the issue of power, who wields it, and what's their incentive to change. In the Middle East, let's first differentiate between transitions and reform or liberalization. Some people confuse the two.
When people talk about transitions, people talk about a collapse of a particular political order and replacing it with something new. What we have in Iraq now is a transition. The entire order has collapsed, and now there are obviously--there is much more opportunity than there was before, but there are also more risks, and there's certainly short-term instability.
That's true about every transition. Most of the time it's unpredictable. As a political scientist, in cases that we've studied, we don't know what the outcome will be. Sometimes it goes backward. Sometimes it goes forward. Almost always it's accompanied by significant instability and unpredictability.
But what we're talking about is more incremental change, reform within a system, not a collapse. We can't predict what will happen if--whether there will be revolutions or political change in Middle East countries. But what we are focused on is how do you get the existing governments to adopt reform measures and to change and evolve accordingly.
The starting point is what is their incentive. Every government is there to protect its power, to survive before it serves its interest, its citizenry. In fact, the service of the citizenry is very much a function of its exercise and wielding of power. And so you have to start with what is the incentive of the governments in the region to change and what cost are they willing to pay--what cost are they willing to pay for change?
If you look at most of the rulers in the region, in the morning the first meeting they will have is not with their economic adviser. It is within the internal security adviser. That is the first meeting. That is the meeting that leads to the primary recommendation that affects everything else that they're going to hear the rest of the day. And unless one understands that in the design of an economic program, one cannot possibly get these governments to adopt the measures that you want.
So what I'd like to address, therefore, is what are the other new incentives for this governments to accept change along the lines that have been suggested by economists and others and people who have looked at it. And I would have to say that the picture is mixed, and I do not--I have not seen a fundamental transformation in the outlook because of any recent events. There has been an incremental build-up, and if you look at a labor market example over a 30-year period, you know that it's an incremental, long-term build-up that it's going to have ramifications at some point. But I do not see a fundamental transformation.
Let me talk about the external incentives to begin with. If you look at the sort of incentives from the outside that would incline governments to reform, politically and economically, first, there could be a fear of collapse. If one can look at the China model, China may have learned that it needs to reform early, but it certainly accelerated its reform model since the collapse of the Soviet Union. There was a clear sort of notion that if you don't, that could be an outcome, that could be a threat.
I don't think the region today faces a similar internalization, certainly not out of the Iraq model. If there is a lesson to be learned from what happened to Iraq, it is don't be on the wrong side of the U.S. That's basically the lesson, I think, that most people have learned. It's not a lesson of, you know, be democratic. And I think that is--and, in fact, in some ways the Iraq issue is likely to play into the fears of the public, because in the short term, as I said, not unpredictably, the Iraq project is one of horrific instability. Instability is scary to people. It is frightening to people. And when people look at the Iraq model, if you live in Saudi Arabia, what you're reading about is the dislocation, the hunger, the prostitution that is emerging, all sorts of things that are socially frightening to you, and it's a model that you don't want to emulate.
So in the short term, in fact, that model is actually going to create more of a public reservation about change that governments are going to be able to exploit.
As far as direct pressure from the U.S. particularly, from the international community, I think if you look at the picture, you can argue that in the past American pressure has had some impact, and it's true in the late 1980s, particularly after the collapse of the Soviet Union. Actually, the first Bush administration tried to highlight the issue of reform, and, in fact, some Arab governments responded--Jordan, Yemen, even Algeria. There were attempts at reform. In some part, this was linked to American pressure--not entirely but clearly in part it was.
Most of these do not appear to have been sustained, and most of the reaction was not really fundamental transformation of the system, but usually artificial exercises that are intended to bide time to right a crisis, and then usually they don't last very long and there are reversals. We haven't seen a sustained effort of that sort.
Moreover, I think if you look at the American agenda at the moment pertaining to reform in the Middle East, one can argue that at one level there has been a shift in American foreign policy, and that shift is sort of internalizing at least a belief among elites that reform in the Middle East is good for America. I mean, that is not just an export of a value but, rather, a sense that somehow the terrorism against America was linked to the absence of reform in the Middle East. There is a widely held view in this town that I think sees it this way. In that sense, the notion of reform has emerged as a high priority in American foreign policy.
But, in reality, I think, when you look at how foreign policy unfolds, national security priorities always overtake the issue of democracy in the short term. And if we, for example, ask the Pakistanis to reform while at the same time we're fighting the war against al-Qaeda, it is clear that the priority of fighting al-Qaeda will trump the issue of liberalization in Pakistan every step of the way. And that is exactly what happened in the relationship with Pakistan.
If we are pressuring the Saudis to reform and then the Saudis respond in fighting al-Qaeda, transforming or at least minimizing the threat of some of the militant Islamist groups and cooperating on the Arab-Israeli issue, I think the pressure is likely to be removed from them on the issue of reform. At least that is the way governments have assumed the case to be, and I think that is the way they assume it to be now. So they're more likely to respond to the policy priorities of America on national security, and in doing so, in a way, not only do they postpone addressing the reform issue, but it can go the opposite way, because the policies that they actually pursue in support of American foreign policy are not very popular publicly. And, therefore, it widened the gaps between them and their public, and usually they seem to--they see themselves being forced to be more repressive rather than more liberal in relation to their public opinion.
So it generates--we've seen this, by the way, over the past year. There has been much more repressive measures than measures of liberalization in most Arab countries in the lead-up to the Iraq war and since the Iraq war. That is, I think, a natural tendency. So I don't see the external dynamic, at least the political dynamic emanating from the U.S. or from some broad fear that is being internalized in the region by the governments to push in that direction.
Let me come to the domestic pressure, and I think that's the one that obviously has been highlighted by my colleagues, the economists.
I think it is true, if you look at one interpretation of why people in the region have been less demanding of political participation, it has been the rent economy model that, in essence, sort of no taxation, no representation kind of model. It's a welfare state. Most of the income accrues directly to the state. The state provides, and to the extent that they can, continue to provide, I think. They're okay, without sharing power and sharing, therefore, responsibility.
Obviously, the numbers are clear. Although there are exceptions to the rule when you look at the small oil-producing countries like Qatar that still have $37,000 per capita income, at the aggregate level it is true that the share of the economy that accrues directly to the government from national resources like oil has been declining over time. And in that sense, the per capita income, as we see, has declined in real terms. You've had the labor pressure. All of that is clearly generating some dislocation and some political pressure on the government to change. That's real. It's not new but it's real, and the question is how do governments react to it. Do they see it as a problem? Do they internalize it as a problem that they have to address?
I think that if you look at the political picture across the region, most governments do see it as a problem. Most governments see it as a problem. Whether they've internalized it as an existential problem or not is a different issue, and I don't think they have. We're talking about a trigger, something that makes them very frightened that they really have to reform. And in that sense, I think the media, the new media in the Middle East has played, one can argue, a double-edged sword.
On the one hand, it has been a release valve that gives the appearance of change and opening without fundamental transformation. On the other hand, it has served to highlight some of the problems in the region, including the corruption, more information, and has provided a layer that is outside the capacity of the government.
I was just in the Middle East. I was in Syria for, I think, the third or fourth time in the past decade, and I must say that I have never seen more openness at the level of the NGOs, the elites, including the government-connected elites, to change, to ask questions, to soul-search, to feel that they have to be connected to the outside world.
There is definitely a dynamic that is a product, I think, of the new media, and that is a product of the change. The question is whether governments see that they have to respond by reforming economically. And in the past, they have just done cosmetic change because they see it as a short-term crisis.
Let me end by saying--by just making two points. One is that if one is designing any economic reform package, you have to do it in a way that does not immediately threaten the government, because if you do, it's not going to work. It has to be seen as a win-win solution. So any program design has to be seen as a win-win for them. You know, this could obviously have a short-term impact, but more importantly, it is likely to have a long-term impact. One can have a strategic vision similar to that in China as saying the process is going to change the system, you know, in the long term, just go with it. I think that's one point that I'd like to make.
The second point, I think, if I had to look at what is missing in the region--we've talked about labor. Yes, but I think the real issue is the absence of skills in the region. I think Hani has his finger on the most critical point. When I examined the educational system in the region, that is the system that is most bankrupt. There are a lot of degrees, but not skilled degrees.
The Middle East, by the way, in terms of percentages, has the worst misfit between the skill and the job of any region around the world.
I think that if I were to design, to highlight one particular issue in the reform process, I would start with educational reform that is based on skills that would fit into the new job market.
MR. Abed: Thank you very much.
Well, I think for our audience you have been offered or presented with a large number of ideas, thoughts, reflections, and perceptions that raise a lot of issues, I'm sure, in your mind.
I would like to open the floor for questions. You can address the question to any of the speakers. The addressee will seek to answer it. Others can come in if they wish at the podium. And in the end, I'll ask each of our speakers to give us a minute and a half summing-up statement, looking forward as to where we go from here.
Any questions from the audience? Please, I think there are microphones near the chairs. So please feel free.
MR. : [inaudible] microphones to your right-hand side. Please just press your red button, identify yourself, [inaudible].
MR. : My name is Masood Kavoossi (ph) with Howard University here in Washington. It's very difficult to cover a region as diverse as the Middle East under one panel with so many different exceptions that exist per country. Acknowledging that, however, I have another observation as far as the role of the isolation that the region is argued to be put in, or has enjoyed, let's call it.
To what extent do we contribute, the role of the U.S. Government over the past decade or so, to insist on keeping some of the key economies in the region isolated? That is to say, sanctions against Iran, Iraq, Syria, Libya, and you name it. Is this necessarily something that the Middle Easterners have failed to absorb or to some degree integrate themselves into the global economy, or has it been a serious obstacle for them to achieve that goal?
MR. Abed: Shibley, do you want to take that?
MR. TELHAMI: I don't know that--I haven't seen a systematic study of it, but it obviously on some countries has had an impact. I mean, it has an impact on Libya, on Syria it had an impact, and it's common sense. If you are an investor--even now, there are no sanctions, major sanctions on Syria, but there's a threat of imposing sanctions on Syria. If I'm an investor, I'm not going to invest in Syria in this environment where there is that uncertainty.
I think the same could be said about a lot of other countries, and I think the Arab-Israeli issue, by the way, while it has been used as an excuse by many of the regimes, of course, to hide their own problems, it has had a structural, profound impact on the economies. I mean, we know that the war certainly has had impact on the economies. But more than that, again, instability and uncertainty. Even a Palestinian American who loves, you know, to help Palestinians on the ground is not going to go and build a hotel today in Bethlehem. It makes absolutely no sense to do that in this environment.
So I think that if you look at the international crisis that is both in terms of the U.S. relations with the region, the Arab-Israeli issue, the Iraq-Iran war, as distorting factors into the economy, I'd love to see a real systematic economic study of it, but it clearly is there.
MR. Abed: Does anybody else want to reflect on that?
MR. : If I could very quickly, the point is extremely well taken, but even if you actually look at it at the individual country level and try to abstract from regional issues, for example, comparing FDI stock to national income, external indebtedness--private sector indebtedness versus public sector indebtedness. So even if you abstract from the region, you still find that the region compares unfavorably to other regions, to other countries--within the countries that have no sanctions, obviously.
MR. Abed: Any further questions from the audience? Yes?
MR. : Thanks. This, in fact, is a question which sort of cuts across all the panelists. I was quite intrigued by the idea that Dr. Telhami put forth with respect to the two forces for change: the external and the domestic. And obviously there's a concern of a limited amount of influence that either of those forces can have. However, those two forces combined together do tend to have a significant critical mass impact.
I'm trying to see the way it worked in the 17th and the 18th century in Europe and elsewhere where the growth picked up, where the domestic forces were combined with the capital flows from elsewhere, which then gave rise to the growth of these economies.
What we need to do essentially is to bring about a win-win combination of the domestic forces with the external forces. In this case, international financial institutions, both the multilateral as well as the capital market institutions, can work with domestic forces for change. What is needed here is creating that critical mass, and then the question is: How do you create the critical mass? Should it be done through a diplomatic change, that is, a strategic change at the international level? Or should it be done and spawned by domestic forces?
At this moment, as I see it, we are all thinking in terms of four or five different areas, but not connecting them. There is a need for connecting them, and that's where the comprehensiveness of the strategy will come into effect. The question is: Who will lead it and how?
MR. Abed: Anybody who wants to take this? Shibley, go ahead.
MR. TELHAMI: You know, I think if you look at it through a lens of sort of subversive good forces, I mean, there are two strategies you can have vis-a-vis an entrenched government. One is to create an option that is seen as advantageous to them. The other is to use the space that is allowed to have a policy that seems benign but that transforms institutions over time and inevitably changes the structure of power. That's the--and I think that in the space allowed category, I think there is a lot of room for interaction because there is a space that has been created by virtue of globalization having reached the Middle East, even though not on the scale that most people would like. There are forces, business forces, NGOs, including government-tied forces, that are allowed to operate, ones that are now operating largely through corruption, that is, they're operating not because there is legal reform but because they have a sponsor in the government who's being paid off, but who would very much like to have a better institutional format to do business, that there is a space of cooperation between those kind of entities on the ground, the economic international institutions, NGOs, and even governments that want to see reform internationally. But I just don't see how you can coordinate that.
MR. Abed: Thank you.
Let's see if we have any questions on structural reform, on the role of the private sector, and financial sector reform. Yes?
MR. : The question to Hani Findakly. I didn't get your conclusion about the prospects for take-off in private sector activity.
MR. FINDAKLY: I didn't offer any. What I was confronted with in looking at where things are headed, looking, say, over the next five, seven, ten years, is this paradox which I call incomplete markets, which I think explains in large part both the slowdown in the reform process and the resistance to reform.
Privatization is one classic example of that. When you privatize, you need to create new management and new shareholders and new financial institutions and new reporting, and a whole transformation in the governance and the way you do business.
If there is no legal structure and no regulatory structure and no financial market that not only allows for the wide distribution of shares of the enterprises to the public and also allows those entities to fund themselves, to raise equity, to raise working capital, to raise long-term debt, it becomes impossible for that new entity to operate. So all you have basically is an entity that was normally owned by the government and now is owned by a new monopoly, which is tied very much to the public.
That's the reason why I thought of the ideas of creating an infrastructure and enabling conditions for the small business formation. And there I hold a great deal of hope because quite a bit of experience, particularly recent experience, in both the developing countries as well as in the advanced countries, for the speed with which you can implement a program of this type, the amount of capital requirement is very small. Entrepreneurs are on the ground. They can impact and affect business plans and solve problems. The amount of regulatory oversight isn't as burdensome, as onerous as it would be otherwise. Those companies tend to grow at a much faster pace than larger companies. So in that line, there's quite a bit of hope and quite a bit of possibilities that could happen.
Where do you make this happen? You make it happen, one, by creating an environment for what I call risk capital. In the U.S. and in Europe, they've created a whole new class of entrepreneurs called the venture capitalists. The venture capitalists provide not only the risk capital for entrepreneurs who have good ideas to start a business, where it's possible for an entrepreneur to come up with a business plan and get $1 million or $2 million of capital, or $100,000 of capital, while it probably could not even afford to buy a good pair of shoes or a good suit. What venture capitalists also do is that they provide the mentoring, because most entrepreneurs are engineers, marketing people, other individuals who know about the business but they don't know the whole other range of issues related to the running of the business, the management, the human capital, the finance, legal issues, labor issues, a variety of other issues that are important for the running and management of the business. That's really the role of venture capitalists, and what you need is to create a similar kind of classes of venture capitalists in the region, plus a similar kind of institutional arrangement that, for example, worked very well in this country, the Small Business Administration, that provides capital to smaller kind of entrepreneurs who are basically able to implement and plan their businesses.
MR. Abed: Thank you.
Does anyone want to add anything to this?
MR. Abed: Okay. Any further questions? Ali?
MR. : Thank you. I want to draw attention to another form of external incentives. Actually, it's like an anchor for reform, which is the accession to the European Union by a number of countries in Eastern Europe. Over a number of years, this accession has provided an overriding political objective that mobilized attention, energy, and political will for reform. And we have seen the result, which is favorable.
Now, unfortunately, the association agreements of the European Union with some of the Mediterranean countries has not provided that kind of anchor. Can we hope that the U.S. initiative to establish free trade agreements with some of the Middle East countries could provide that kind of anchor?
MR. Abed: I'll let Mustapha speak on that a bit and then...
MR. NABLI: Well, that allows me to make a general point on this issue of pressure. I happen to believe that really the change can only come mainly from within, and pressure, I'm talking about pressure, I think at least in the region is not something that is very helpful.
What is helpful is to help and to provide support and ideas and help those who deal with those issues to understand them better, and then, you know, kind of advocate change and so on. But thinking of it as pressure, I think, is not the right way to go.
On the EU issue, the problem with the comparison between the accession and the Med countries is that the accession countries, it's a contract between the acceding countries and the other European countries. There was a contract. You are going to come in. You are going to get something, and you are going to be part of the family, you have to play by the rules.
So in order to get into the family, you have to play by the rules, and the rules are this book and then the active communitaire is 15,000 pages, and then you have to implement them. And then you go and you have ten years to implement them.
So the problem with the EU-MED is that it does not have that type of contract, because essentially what it has is that the agreements were agreements for free trade area, and the free trade area essentially brings benefits to the Europeans. Actually, it does not have much for the other side because the access to the European markets did exist before. So the FTA agreements did not add much except open the markets of the Med countries to the imports from Europe.
So what are you providing them in terms of--it's not much, except the financial protocol, the amount of money that is supposed--which has contributed this, what I was talking about in terms of sustaining the rents. The increase of aid actually was counterproductive to my mind because it helped sustain the prevailing system rather than helping to push for reforms.
So I think certainly--and I have to say we have been promoting these ideas with the Europeans. They have to review the kind of agreement because the way it is now, really it's not helpful that much, and I have to say I was part of the first agreement to be signed, so I know a little bit how it was. But I think that's a different story. But the way it is, I don't think the incentive system that is built into that code is conducive to what you are trying to see.
MR. Abed: Let me see if we can conclude. Any final question from anyone? But it has to be short and quick. Yes?
MR. : My comment relates to the issue of education. Can you actually generalize in terms of education as far as the region is concerned? I mean, there are some of those countries that actually do have, I think, highly educated people. You can see the evidence from the fact that some are net recipients of very qualified people in their labor market. Is it possible perhaps to look at this issue in a more disaggregated fashion?
MR. Abed: As I mentioned at the beginning, there are risks in generalizing. For every generalization, there are enough exceptions to provoke discussion. But I will invite my colleagues here to conclude, if they wish. It's an option to speak for about a minute and a half, if you wish, to bring your thoughts together and your final message. But the idea today was provoke some thinking on some of the overarching issues in the region, which don't apply to every single country, but certainly remain on the minds of the policymakers, on the minds of those like ourselves who are engaged in policy discussions with the region.
Let me then turn to my colleagues, starting from the end. Shibley, if you wish to conclude with a brief statement, please do, and then I'll try to wrap it up at the end. We have about four or five minutes.
MR. TELHAMI: I think education is a central issue, and I do not actually agree that the Middle East has a highly educated population. I think that superficially, yes, there are a lot of college graduates who are unemployed. I think the reality of it is--I've been doing a little bit of study of the educational system in the region recently, and it is a very tragic system. I think there is no cutting-edge research department of any kind in almost any of the Arab countries in any field. By cutting edge, I mean large, major scale.
I think that what you have is the very successful Arab educated elites end up in other departments. That's why they don't go home. If you're a physicist, you're well trained, you are--you can't be part of the department if you don't have cutting-edge research. You know, you just--that's not something you will go (?) .
So I think that if you look at the kind of education in terms of the skills and the level education we're talking about, Damascus University has over 100,000 students, classes over 500 students often. If you look at sort of, you know, what you could hope to convey to the student in this environment of globalization where skill is everything, where a company in San Francisco hires an accountant from the Philippines through the Internet and taps into it because they do have the skill, I don't see it in the Middle East.
And I would say while it's to varying degrees--you know, you talk about generalization. Of course, it's true some countries are better than others. But aggregately, it doesn't look good. And I think that if I had to say there should be one priority of reform of any kind, I would say it's education above all else.
MR. NABLI: I would like maybe to finish on a slightly different note. I think we have tended probably to be too pessimistic, too negative. And I would like to correct a little bit that because I think actually when you go and see what's happening, there are lots of things happening on the ground. They're young people. Maybe they're not--they don't have the skills that are--there are lots of people who are young and who have some education who are doing extremely marvelous things. There are, you know, people in governments trying to do things. There are people in the business world doing things. There are people in NGOs. There are lots of things happening on the ground. So let's not say that, you know, it's blank and it's, you know--it is not. There is a lot of liveliness out there and so on.
On the other hand, the challenge is huge. What is needed is a huge transformation of the system, both the economic system and the political system. And the challenge is how to make these forces, you know, be forces for change to make this happen. And I think our role is to help and not to pressure or to impose, because those things do not get imposed by the end of the day. They have to come from within.
But these forces exist. They are there. They can be supported. They are eager to be supported. And I think that's what we should be doing.
MR. Abed: Thank you, Mustapha.
MR. FINDAKLY: I'll leave you with a couple of thoughts. The two most abundant things that the region has is a lot of people and a lot of money. I actually believe the second to be true as much as I believe the first one, because it's tangible and measurable.
The real challenge is how do you, you know, take advantage of those two issues, (?) capital and a growing labor force, growing population, from a challenge and a problem into an opportunity and a benefit. I think there are ways to do that, and I think the private sector is the only mechanism that today exists for it.
Somebody had mentioned about the fact that a number of these issues need to be connected together, the issues of education, the skill building, the issue of regulation and legal issues. And I think it's a role probably, whether the pressure is coming from outside or from inside, every government in the region that I have spoken to is fully cognizant of those risks and of those opportunities. What they need is a guide to sequence and to prioritize these issues, because doing half the things, the macro, for example, reform, and leaving the other stuff not done will only raise resistance to change because they will show that reform has not worked, when in reality it's that half of the reform did not work. It's like building a bridge halfway across a river. It doesn't get you to where you want to go and you need to finish that other half.
It is, I think, the role of institutions like the IMF and the World Bank to guide through that process, to make that happen from the inside as compared to political pressure from the outside, because I think it would be resisted both by the government and by the people themselves.
Thanks very much.
MR. Abed: Thank you, Hani.
MR. Bisat: Thank you. I'd like to sort of finish with a mundane and an inspirational point.
The mundane point that I wanted to stress again is that I think there's an issue of sequencing in reform that we tend to ignore in the Middle East. The emphasis should very well be at this stage on the domestic reform side at the expense of potentially ignoring external liberalization; and that within that sequencing, there's a need for a push for a second generation of reform after the first part in the mid-1990s.
My second inspirational point is more of a thought than a question. Historically, this strikes me the third episode over the past century that could open an opportunity for a new renaissance. We had one at the turn of the century in the switch between the Ottoman Empire and the Western colonization. We had another one in the early 1950s with the rise of Arab nationalism and all the hope and inspirations that came with it. And we seem to be at a third juncture right now. Those massive shocks created massive and profound changes in our societies, which at one point looked very promising, and I'm hoping that we are at the third stage now.
MR. Abed: Thank you. I only wish to say that I very, very much appreciate your indulgence and your participation with us in this forum. We in the Middle Eastern Department, as you know, are trying to engage in a dialogue on policy issues in the region. We are trying to understand better, listen better to the policymakers, to the reform-minded officials who wish to improve the conditions of their own countries and their own people. We try to understand what the agenda is. We try to embed our ideas into the domestic agendas. We are trying to see how we can help these countries move faster and undertake reforms that run deeper so that the region and the countries of the region can grow at higher rates, can provide the needed prosperity and freedoms that their own people yearn for.
We very much appreciate the participation of our distinguished panelists. We are grateful to all of them for taking the time to think through some of the issues and to come to offer here some of their ideas, which I found at least very enriching and very provocative, at times, but very instructive and very helpful.
Again, thank you all for this opportunity, and I look forward to staying in touch with some of you on some of the issues you have raised as we proceed with our work in the region.
Thank you and have a very good afternoon.
[Whereupon, the meeting was adjourned.]