Home Banking & Finance Is Lebanon technologically ready to tackle growth?

Is Lebanon technologically ready to tackle growth?

To avoid being left behind, the country needs better education, good governance, and lasting stability

by Paul Karam

In March 2017, The Economist reported that Intel, the giant American chipmaker, paid $15.3 billion for Mobileye, an Israeli firm at the forefront of developing autonomous-car technology. The deal was not the first to involve an Israeli tech firm attracting foreign buyers, but it was the biggest yet. The Mobileye acquisition is an example of how Israel’s technological edge has strengthened its economy, and a reminder of the crucial role that technology and production efficiency play in the growth process of any economy today.

Of course, very few countries have the necessary elements to create an edge in technology—especially if they are a developing country, and more so if they go through recurrent political instability. Lebanon is generally known to have an educated workforce, and during the postwar rebuilding period it benefited from considerable capital accumulation. But it has also been subject to political setbacks that have sapped its energies.

One way to understand Lebanon’s growth process and the role of technology in its economic development is  to examine what the American economist Robert Solow called the sources of growth, or the factors that contribute to gross domestic product (GDP): human labor, physical capital, and total-factor productivity (TFP). TFP measures the contribution to GDP that cannot be explained by labor or capital—in other words, it captures extra factors that affect the overall efficiency of production, like political stability, technology, human capital, governance, institutional quality, and cultural traits.

Research published in 2003 by Barry Bosworth and Susan Collins of the Brookings Institution shows that for developed economies, TFP contributes close to 40 percent of growth in output, making growth an “intensive” process that is dependent on technology and the quality of inputs. But in developing countries, TFP contributes no more than 10 percent to growth, clearly indicating that growth is still heavily reliant on the quantity of inputs.

The picture is worse for Arab countries, where the contribution of TFP has been zero and sometimes negative, according to 2007 research by Aamer Abu-Qarn and Suleiman Abu-Bader published in the journal “World Development,”  which implied that TFP has held back production efficiency and economic output due to technological underdevelopment, political instability, and institutional weakness. These outcomes did not spare the buoyant, modernizing countries of the Gulf Cooperation Council (GCC). Evidence compiled by Raphael Espinoza in a 2012 research paper for the University of Oxford shows that TFP growth was negative for all GCC countries between 1990 and 2009, and only positive for three countries when non-oil output is considered: Kuwait, Oman, and UAE, which had an annual TFP growth of 0.9, 0.8, and 0.2 percent respectively.

The two glaring exceptions to the international picture are China and Israel. China has returned to the world economic stage with gusto, averaging an annual GDP growth rate of 9.2 percent between 1978 and 2004, and, just as importantly, an average TFP growth of 4 percent—translating into a TFP contribution to output growth at 43.5 percent, which is even higher than that of developed economies. While less advertised, Israel’s experience has been equally notable: GDP growth in the same period averaged 4.3 percent and TFP growth 1.97 percent, indicating that the TFP contribution to output growth was at 45.8 percent.

Politics affects growth

What about Lebanon? The table, from research done by the Lebanese economist Ali Bolbol, displays the growth accounting numbers for Lebanon between 1992 and 2015, and for four consecutive sub-periods within these 23 years. Overall, GDP growth was 4.69 percent, but TFP growth was 0.52 percent annually, thus contributing only 11.1 percent to growth.

Growth was driven mostly by physical capital accumulation at 2.43 percent, which thus contributed more than 50 percent to growth. Interesting patterns emerge in the sub-periods: During the rebuilding period of 1992–1998, growth was notably characterized by TFP at 1.95 percent, but more so by capital accumulation at 3.21 percent. A slowdown period followed, which was characterized by political bickering and culminated with the assassination of Prime Minister Rafik Hariri in 2005. TFP dropped precipitously during that period, robbing from growth at the rate of 2.33 percent annually.

The subsequent 2007–2010 period was underpinned by the Doha Accord of political reconciliation. TFP did well, growing at 2.24 percent, but the construction boom in the real estate sector had the biggest effect, with capital growing at 5.49 percent and contributing more than 50 percent to growth. The last period, 2011 to 2015, was the most dismal, marked by internal political paralysis and the Syrian war. TFP contracted at a rate of 1.77 percent annually, and even capital accumulation suffered due to the dearth of investment, growing at only 0.98 percent. Labor growth saved the day, growing at 2.85 percent, thanks in part to inflows of low-cost Syrian labor. It contributed more to Lebanon’s GDP growth during this period than capital growth and TFP combined.

Overall, post-war Lebanon has fared better than its Arab counterparts. Capital accumulation explained slightly more than 50 percent of its growth, whereas TFP growth was positive and contributed close to 12 percent to growth. But compared to countries like China and Israel, Lebanon has done poorly as far as TFP is concerned—that is, in terms of technological development and the quality of inputs.

It was always quite evident that political stability matters greatly to growth; now, we can put an approximate number on it. As reflected in TFP, we saw that between 1999 and 2006, political instability denied the economy 2.33 percent annually in growth, whereas between 2007 and 2010, political stability added 2.24 percent. This is the minimum impact, since instability can also affect labor utilization and capital investments.

But TFP captures more than the impact of politics. What Lebanon needs is not only continuous political stability, but also a climate that fosters innovation and technological growth. Focusing on technological growth is one of the most effective ways to boost TFP, and, with it, overall growth. In this respect, Banque du Liban, the central bank of Lebanon, took a welcome step in the right direction with Circular 331, an initiative to channel bank investments into “knowledge economy” entrepreneurs establishing companies in Lebanon through direct investment or via a locally based venture capital (VC) outfit. However, this was an isolated event within a sector that lacks momentum and a VC culture, in an overall environment that still remains cumbersome to invest in, because of a lack of modern regulations and good governance. The government must clear the way for investing, and the private sector must seize these incentives and take on investments that can ultimately transform the economy into a modern, technology-driven economy.

The private sector will need first and foremost an educated labor force to carry out these structural changes. The popular perception that the Lebanese education system is extraordinary may not hold water: TFP growth in post war Lebanon has been low, and the contribution of education small. A 2016 UN report on Lebanon, “Mind the Gap,” argues that the country should design an educational system that focuses more on new technologies and applied sciences, reverses the widening skills gap, and exploits cooperation between universities and the private sector.

Lebanon’s comparative advantage no longer lies in services, given the emerging and competing centers in the region, like Dubai. Technology is now  the undeniable driving force behind growth and the rise of modern economies. Post-war Lebanon is still lacking in this respect, as apparent in the country’s relatively low TFP. It can reverse this pattern by maintaining political stability, enriching human capital and talent, and improving governance and the business environment. If it fails to do so, the country will lag increasingly behind its peers, and move toward a dimmer future.

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Paul Karam

Paul Karam is a graduating senior student of economics and mathematics at the American University of Beirut.

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