The Challenges for the Arab World in the Global Economy: Stability and Structural Adjustment -- Address by Michel Camdessus

May 20, 1996

96/8 Address by Michel Camdessus
Managing Director of the International Monetary Fund
at the
Annual Meeting of the Union of Arab Banks
New York, May 20, 1996

Thank you, ladies and gentlemen.

It is a pleasure to join this major forum and to have this opportunity to speak to you about the challenges facing the Arab world in today's global economy. Taken together, the 21 Arab economies of the Middle East and North Africa contain two-thirds of the world's oil reserves. They also have a long entrepreneurial tradition and many highly-skilled people. These are among the solid reasons why the Arab countries--your countries--have the potential for strong economic performance. At the same time, the financial institutions that you represent have an important role to play in ensuring that these countries fulfill this potential. So let me take this opportunity to give you my perspective on the globalization of the world economy and the challenges it presents, especially for developing countries. I will then discuss how Arab countries can prepare to meet these challenges and how the region's financial institutions can contribute to the process.

I. Globalization

There is a lot of talk these days about globalization--about the opportunities it brings and the risks that it entails. In my view, globalization is a highly favorable development, especially for developing countries. Thanks to the globalization of the financial markets, net private capital inflows to developing countries have soared from an average level of $10 billion per year in the mid-1970s, to over $100 billion per year in the first half of the 1990s, and to $166 billion last year. These inflows have given countries additional opportunities to increase investment, modernize technology, raise production, create new jobs, and accelerate growth. Similarly, the rapid expansion of world trade has brought increased export opportunities, especially for developing countries, whose exports have been growing at an average rate of close to 10 percent per year during the last five years. Indeed, the greater availability of international capital, the much reduced cost of international communications and transport, and the expansion of world trade are having a profound effect on the international economy. As a result of these trends, a country's economic progress is much less dependent on its geographic location and endowment of natural resources than it was even a decade ago. Rather, economic prosperity increasingly depends on the quality of a country's domestic investment climate, the skills of its workforce, and the ability of its producers to respond quickly to opportunities in the global marketplace.

But, of course, globalization also involves risks. Last year's experience with Mexico brought home all too clearly how quickly market sentiment can shift and how disruptive such shifts can be. Likewise, the Barings case illustrated the perils of inadequate internal bank controls and financial sector supervision in today's global markets. But in addition to these risks, there is a further and, to my mind, greater risk--the risk that some countries will not be able to attract international capital, increase exports, or otherwise take advantage of the opportunities that globalization provides. For these countries, there is the very real danger that globalization will not mean increased investment, exports, and growth, but economic stagnation and marginalization.

II. Economic Performance of Arab Countries

So where, you may ask, do Arab countries stand in today's global economy? Well, let's say that their responses to the present challenges are quite diverse. Certainly, it is encouraging to see that some countries in the region have made considerable headway in stabilizing, reforming, and opening up their economies. Here I might mention three examples, among others, as being particularly noteworthy:

Algeria, whose steadfast implementation of its comprehensive stabilization and reform program since 1994, despite severe political and security problems, has helped produce the first increase in real per capita income in five years;

Jordan, whose determined pursuit of prudent macroeconomic policies and structural reform since 1989 has resulted in strong, broad-based growth averaging 6 percent during the last 3 years and a substantial reduction in unemployment, despite high labor force growth; and

Tunisia, whose transformation from an inward-looking and heavily regulated economy in 1986 into a predominantly market- and export-oriented one today has made the country much more able to withstand external shocks; increased real per capita income by an average of about 2 percent per annum since 1987; and permitted major improvements in health, education, and other social indicators.

I could also mention Morocco (in spite of the drought), Saudi Arabia in its ongoing financial adjustment efforts, and so on. But despite such achievements, I am concerned that Arab countries as a group are operating below potential--that they are not, in fact, taking full advantage of the opportunities that the global economy has to offer. This can be seen in the fact that even since the 1989 recovery in the region, real GDP growth has not kept pace with the robust growth in developing countries as a group. More to the point, slower GDP growth and rapid population growth in the Arab countries has meant that, for the region as a whole, average real per capita income has virtually stagnated. At the same time, Arab countries as a group have attracted very little of the private capital that has surged into developing countries in recent years; nor has their export growth, which has averaged only 1 1/2 percent per year during the last five years, come anywhere close to the nearly 10 percent average annual export growth achieved by developing countries as a group, or even the 6 percent average annual growth in world trade.

As for the future, it does not appear that the traditional sources of growth in Arab countries will provide the needed basis for sustained economic expansion. Indeed, the outlook for oil prices is uncertain. Without stronger, broad-based growth, how will Arab countries be able to create enough jobs to absorb new entrants to the labor force, which is expanding at over 3 percent per year? Indeed, the already pressing need for job creation is likely to intensify, since, in some countries, more than half the population is under the age of 15. And without stronger growth, how will Arab countries have the resources to upgrade their economic infrastructure, address the problem of water scarcity, or meet the health, educational, housing, and other needs of their growing populations?

III. The Agenda for Reform

Against this background, it is clear that the Arab world needs to improve economic performance and take fuller advantage of the opportunities in today's global economy. But how? I must tell you frankly that in a number of countries in the region, better economic performance and fuller integration into the global economy will require a fundamental reassessment of the role of the state. It is now nearly universally accepted that the most effective economic strategies are private sector-led and outward-oriented. Such strategies have been the secret of success in East Asia, and increasingly they are producing results in Latin America, Eastern Europe, and elsewhere. Conversely, there is ample evidence that when the state dominates the economy, resources are often misallocated, and private investment and growth suffer. To be sure, governments do have an important role to play, but it is an enabling one--the role of ensuring that domestic conditions are such that the private sector will have the confidence to save, invest, and produce. How can governments fulfill this role? Let me share with you what we have learned from the experience of the most successful countries and, accordingly, what we are advising your governments.

To begin with, we tell them that they must pursue disciplined and predictable fiscal and monetary policies. In particular, government deficits must be reduced to a point where they can be financed in a non-inflationary way and do not crowd out private investment or require the drawdown of foreign assets. For many countries in the region, this will require strengthening the tax base--by reducing import duty exemptions, replacing high trade taxes with broad-based consumption taxes, and improving tax administration. It will also require reducing expenditure--by curbing the growth of the government wage bill, and cutting such unproductive expenditures as subsidies and defense spending. Privatization has an important role to play in this regard. At the same time, governments need to improve the quality of expenditure--by redirecting spending toward education, health, and well-targeted social safety nets.

In view of the experience of the most successful countries, what else does an appropriate government role involve?

It involves undertaking a critical mass of structural reform to improve resource allocation, facilitate participation in international trade, encourage private capital inflows, and increase productive investment, jobs and growth. Partial reform may not elicit much response if substantial impediments to reform remain in place.

It means simplifying regulatory systems so that potential investors, both domestic and foreign, will not be deterred by endless red tape, but attracted by a simple and clear set of rules, impartially applied, under which the private sector can flourish.

It means establishing sound financial systems and flexible markets that promote an efficient allocation of resources--a point I shall return to in a moment.

It means promoting transparency so that economic agents--domestic and foreign--understand what the country's policies are and how it is performing. In this connection, I might add that in a globalized world economy with large capital flows between countries, there is a premium on transparency. International capital markets function more smoothly if reliable, regular, and up-to-date information on economic performance is available. Thus, we at the Fund are encouraging all our members to upgrade their statistical systems and to pay special intention to disseminating key data to the public on a timely and regular basis. I might also add that we have recently established a voluntary Special Data Dissemination Standard, aimed at countries participating in international capital markets or aspiring to do so. We would hope that an increasing number of countries in your region will consider subscribing to it.

It is also the role of government--as well as private sector leaders--to build a domestic consensus in favor of economic reform; they must convince their people that developing a modern, efficient market economy is the only way to provide the jobs, economic security, and rising standards of living to which they aspire. When such a consensus exists, governments are more likely to persevere with macroeconomic stabilization and structural reform. And when both the policies and the consensus on reform are in place, savers and investors see that reform is irreversible, that the country is truly integrating into the global economy, and they become less hesitant.

Finally, it is the role of governments to recognize--and to have it endorsed by public opinion--that there is no such thing as prosperity in isolation and to continue devoting part of their national resources to the support of development efforts in poorer countries equally committed to reform. Here let me salute the long-standing contribution of Arab countries in this domain.

My friends, you will tell me that I am reading you the textbook! And to a large extent this is true...but in my everyday life, I see too much of a difference between those countries that implement such policy changes and those that still hesitate, or that only stay half way on the proper course, not to take advantage of every occasion to repeat this message. And the message also applies to you!

IV. The Role of Financial Institutions

As I mentioned, financial institutions also have an important role to play in helping your economies realize their full potential. Banking systems fulfill essential functions in intermediating between savers and investors, financing private sector trade and investment, and helping to ensure that the economy's financial resources are allocated efficiently. Well-functioning banking systems also increase the effectiveness of macroeconomic policy by providing a channel for monetary policy signals.

But to play these roles effectively and, thus, contribute to economic growth and development, the banking system must be sound and efficient. Governments and banks should work together to ensure that this is the case. Governments, for their part, can do so by pursuing sound macroeconomic policies and exercising appropriate bank supervision; banks, for their part, can contribute by upgrading their technology and improving credit analysis, while ensuring that adequate internal controls are in place.

And, as with other sectors of the economy, banks also benefit from competition. Indeed, easier entry--both for foreign banks and newly established domestic ones, provided that they are properly licensed and capitalized--would encourage more efficient operations throughout the sector and, hence, more efficient financial intermediation within the economy as a whole. Admittedly, this may not be a welcome prospect for some institutions. Nevertheless, it is important to bear in mind that a modern, efficient banking sector and a dynamic economy are mutually reinforcing. For example, when banks become more efficient, intermediation costs decline. Likewise, when banks base their lending decisions on sound credit analysis, they allocate the economy's financial resources more efficiently. Thus, modern, efficient banks contribute to economic growth and development. By the same token, faster growth and development increase the demand for financial services. Moreover, as policy reforms in Arab countries gain credibility, your institutions are likely to be the main intermediaries for Arab investment capital returning to the region, as well as an important conduit for other private inflows. From this perspective, your institutions are natural supporters of credible and sustained economic reform in Arab countries.

I think you will agree that the agenda of stabilization and reform that I have described to you today is a demanding one. Yet given the increased competition for investment capital and export markets in today's global economy, there is no alternative but to begin the adjustment process as soon as possible and to persevere on a steady course of reform. I want to assure you, however, that countries that embark on this course can count on the support of the IMF and, indeed, of the international community at large. The IMF, for its part, has policy consultations with virtually every country in the region at least once a year and is extending technical assistance in such areas as fiscal and monetary policy and exchange rate arrangements throughout the region. We are also helping to finance stabilization and reform programs in six Arab countries with balance of payments needs, and we presently have several programs under negotiation in the region. Of course, we are extending this assistance in cooperation with other international institutions and various bilateral donors that are also providing support.

But as important as IMF and other official assistance is, especially for the poorer countries in the region, let me assure you that the greatest support for Arab countries, or indeed for any country committed to reform, will not come from governments or international institutions, but--when the conditions are right--from the vast resources of the private sector, both domestic and foreign. Attracting these resources is the ultimate challenge in today's global economy, a challenge that I have no doubt Arab countries--and their banking institutions--will take up forthwith; if a single word were to become an anathema in your region, it should be Boukra!


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