The onset of the new millennium saw a welcome reversal of fortunes in the Arab world after nearly two decades of disappointing economic growth. The regional GDP increased in real terms by an average rate of 6.3 percent in 2006, up from 4.6 percent during the first four years of the decade and from only 1.7 percent during the second half of the 1990s. On a per capita income basis, the region grew at an average of 4.2 percent in 2006, the highest level recorded in the last two decades. Unemployment declined from more than 14 percent in the late 1990s — when it was twice as high as the world’s average rate of unemployment — to 10 percent by 2005. In fact, the share of youth among the unemployed, which had been increasing since the 1970s, was also reduced. The euphoria of the last 10 years came into question suddenly in September 2008 with the financial crisis that started in the US and set in motion wide-ranging adverse effects on the world economy. Many countries have already sought rescue packages from the IMF and others are trying to come up with homegrown solutions. The global economy is expected to slow appreciably in 2009, with growth of less than two percent — compared to five percent in recent years. Significant declines are expected in some countries, including the US economy whose contraction is expected to be at least one percent. China’s growth rate of 12 percent a year earlier came down to six percent in the third quarter of 2008.

How long will the effects of the current crisis last? Following the Great Depression that started in 1929, the Dow Jones index did not recover its value until 1954 — a full 25 years later. Previously, the Long Depression that started in 1873 and, incidentally, marked the beginning of the decline of the British Empire, did not come to an end until 1896 — 23 years later. Whether the current crisis will also mark the decline in American hegemony is uncertain, but what is certain is that its effects will not wither away over a year or two. The real issue with financial crises is not so much whether individual investors will lose their money, or whether the crisis in the financial markets will last for five years or 25 years. More pressing are the short-term effects of crises on the ‘real’ economy as people live only once. What matters for them is wages, employment opportunities and the availability of social services. Advice on what to do is already plentiful. Policies that would regulate the financial markets better, create a more balanced role for the government in the economy and provide adequate social protection are already underway and all seem reasonable. But what is often forgotten is that dispelling misconceptions can also be productive and less costly, if not easier, to implement. What are the myths that haunt the labor markets and the broader economies in the Arab world? And what are the lessons from the recent economic revival that provide a clearer understanding of what to do and what not to do?

Myth 1: Luck is in the oil

Some kinds of luck are hobbling, even when they seem to help. While having oil reserves is considered to be a blessing, an often-heard term in the region is the ‘oil curse.’ Regional oil-economies do well when the price of oil — temporarily— shoots up, but then may experience negative growth when prices fall. Overall, on the basis of the economic growth rate, the non-oil economies have done better than oil-based economies after the effects of the first oil boom, which began in 1973, faded away. In fact, in the 1960s and 1970s, economic performance in the Arab region was not only comparable with that in East Asia, it was actually superior in many respects. For example, the region had higher rates of labor productivity and total factor productivity (TFP) than the East Asian tiger economies. The reputation of the East Asian miracle rests mainly on the fact that productivity growth collapsed in the Middle East and North Africa (MENA) region after the mid-1970s. Overall, between 1980 and 1993, the MENA region experienced an average decline in per capita GDP of 2.4 percent compared with worldwide positive growth that averaged 1.2 percent. With declining revenues, the growth in labor demand slowed down. With this came stagnant — even decreasing — wages and higher unemployment in many countries, especially among younger job seekers.

Youth entrants to the labor force are better educated, more productive and adapt more easily

Myth 2: There’s too many people

An often heard but rather impressionistic argument in the Arab world links unemployment to the fast population growth. While rapid population growth and high youth unemployment rates may well appear to be correlated, rising numbers of youth can be seen as a blessing because new entrants to the labor force are better educated than existing workers, can improve the quality of the labor force and are likely to be more productive as well as more adaptable to changing jobs throughout their working lives. In addition, the resulting increase in the number of workers versus pensioners lowers the dependency ratio and can enable governments to reform their currently unsustainable pension schemes, thus, improving the fiscal balance in the macroeconomy. Finally, low dependency rates can also cause individual savings and investment to increase. In any case, the rate of growth in the MENA labor force has declined by almost 10 percent since 1990, from four percent per annum to 3.7 percent per annum and it is projected to be only 2.2 percent within the next decade. Accordingly, the yearly inflow of workers into the region’s labor force is projected to decline from the current 3.9 million to 3.4 million.

Myth 3: Youth unemployment’s to blame

Schemes for combating youth unemployment have preoccupied regional governments for quite a long time and legitimately so. Given the young structure of the population, the same unemployment rate will produce many more unemployed youth than unemployed workers in their 40s or 50s. The effects of unemployment upon the youth are often disturbing. Some link the rise in antisocial behavior — or even terrorism — to youth unemployment. Government programs and projects for the youth abound in the region. Many governments use training and retraining, employment offices, wage subsidies, self-employment support and micro-credit to support employment creation among the youth. Moreover multimillion-dollar regional efforts to address youth employment issues are under way, for example the Maktoum Bin Rashid Foundation in Dubai or SILATEC in Qatar. Surely such schemes can have some impact but do they address the root of the problem in an effective way? Evidence shows there is nothing special about youth unemployment compared to unemployment in general. Youth unemployment exists because the economy does not generate jobs. Countries that have high adult unemployment also have high youth unemployment. What Arab economies need is policies for economic growth. Policies for the unemployed are needed when policies for growth fail. To use the medical analogy, drugs are useful but they are a poor substitute for good health.

Myth 4: More education is always better

The Arab world has made great strides in increasing school enrollment. In 1960, the region had the lowest average years of schooling in the world, even less than in Africa and South Asia. By 2000, the region was just behind Latin America and East Asia, having increased average schooling from barely one year to just under six years. Moreover, the last decade has witnessed some spectacular education initiatives in the region. Renowned universities, international medical schools, schools of government and business schools have all settled in large numbers, not only in the GCC, but in countries with lower incomes as well. But this education has not gone very far. Most Arab countries score below average in standardized international education tests. For example, in the latest Trends in International Mathematics and Science Study (TIMSS 2007) none of the 13 participating Arab countries scored above the international average of 451 points. Top performers, such as Taiwan, South Korea and Singapore, scored nearly 600.

Qatar occupied the last position among participating countries (49th out of 49 with a score of 307), proceeded by Saudi Arabia (47th with 329), Kuwait (45th with 354) and Oman (42nd with 372 points). Note that all four are GCC countries, perhaps suggesting that the oil curse may be operating in complex ways. In short, while there has been impressive progress in expanding education, it is questionable whether education institutions provide enough knowledge of sufficient quality, and the relevant skills, needed for the sustained growth and competitiveness of the regional economies. Lack of skilled workers is obviously more of a binding constraint to growth in more rapidly transforming countries  — such as GCC members — but it is precisely students in these countries that perform poorly despite the very high education spending in those nations.

Myth 5: Women steal jobs from men

At around 30 percent, the labor force participation rate of Arab women is the lowest in the world. By comparison, more than 60 percent of women work in Africa, Europe and Central Asia, while their numbers reach more than 75 percent in East Asia. However, the female labor force participation rate is increasing fastest in this region. And a greater economic role for women should be welcomed, not feared. Arab women have not only made phenomenal strides in education over time, but their level of education in many countries now exceeds that of men. Gender parity in basic education is almost complete. Only Djibouti, Iraq, Morocco and Yemen still have significant secondary education gender gaps. In universities, female students outnumber male students in Algeria, Bahrain, Jordan, Kuwait, Lebanon, Libya, Oman, Qatar, Saudi Arabia, Tunisia, the United Arab Emirates and the West Bank and Gaza. Even so, women’s economic contributions have not exceeded that of men’s. History tells us that women do not displace men in the labor market. Nothing summarizes this relation better than a look at the long-term increase in women’s employment in the US economy [shown in the graph above]. The small decline in male participation is due to the increasing education enrollment of men and the greater availability of pensions over time. Of course, there is no reason for the Arab world to follow the employment patterns or gender values of American society. But a look at the employment changes in Kuwait does not produce a much different picture than in the US, or for practically any other OECD economy.

Myth 6: Recent growth has been jobless

While it is generally recognized that globalization boosts economic growth — as in the production of goods and services — there is greater skepticism, especially in the Arab region, about its impact on employment creation. In fact, some regions have recently experienced not only slow employment growth — such as the former socialist countries — but actual declines in employment, as in South Asia. The issue here is not the likely effects of globalization in general but the actual effects in the Arab economies. The employment gains in the region surpassed those in all other regions. This is not just a relative effect, but a noticeable one on its own right. To achieve an annual rate of employment growth of four percent per annum is by all accounts impressive. As argued below, the regional gains came from the declining role of government employment and the growth of the private sector.

More than half of all the region’s civilian workers are employed outside agriculture and industry sectors

Myth 7: Development means manufacturing

It is not just the so-called ‘Arab socialism’ that tempts regional economists to focus on industrial and/or other visible activities as outputs, as having a heavy steel plant or the highest building in the world can be neither missed nor dismissed. Japan’s reliance on industrial exports in the 1960s, South Korea’s in the 1970s, Thailand’s (and other East Asia tigers’) in the 1980s, and China’s since the 1990s all attest to the importance of having something worthy of international trade in order to expand the limited size of a domestic market. But looking at the recent changes in the economy and labor markets in the Arab world, it seems that there are promising ‘locally grown’ alternatives to economic development. The economic revival of the 2000s has been associated with an increase in the share of services in the economy. Services now account for the majority of employment in many regional economies and if non-tradables — such as construction — are included, more than half of all of the region’s civilian workers are employed outside agriculture and industry, with the exception of Morocco where the share is still a respectable 43 percent. This is a welcome development because the manufacturing sector in most Arab countries has been declining for the last 30 years both in terms of value added and employment. Manufacturing now accounts for only around 15 percent of the region’s employment.

Myth 8: Public sector jobs are mandatory

The historic role of Arab governments in employment ‘creation’ cannot be overstated. Even as late as the 1990s, the public sector accounted for more than 35 percent of all new jobs in countries such as Egypt and Algeria. It is no surprise that public sector employment per capita is highest in the Arab world, as is the share of public sector wages as a percentage of all incomes. This over-reliance on the public sector reaches extreme proportions in the some GCC countries where more than 90 percent of nationals are employed in public sector jobs. In fact, in these countries many of those employed in the private sector are not dynamic young entrepreneurs but older retired civil servants.

In fairness to the governments in the Arab region, with the exception of some GCC countries, employment in the public sector has slowed down in the last decade or so. Most of the employment growth in recent years has come from jobs in the private sector, while in some countries, like Morocco, the public sector has actually shrunk.

With light shed upon the economic myths, we can now draw lessons from the relatively fast economic growth of Arab economies in the last decade.

Reliance on the public sector and the crowding out of the private sector choked regional economies

Lesson 1: Let the private sector employ

The last myth, that increased public sector employment can avert unemployment, provides an explanation as to why employment creation was slow and youth unemployment was exceptionally high in the more distant past. The reliance on the public sector and the crowding out of the private sector choked off many regional economies. Moreover, it created unfounded expectations, most noticeable in the GCC, that the government can and should provide jobs. Though some of the recent positive results in the labor market have been due to the high international price of oil, there has also been a move away from ‘big government’. In many regional countries since 2000, the rate of expansion of the public sector has been less than half of its growth rate in the 1990s.

Meanwhile, many governments have promoted the growth of the private sector. Privatization reforms are being undertaken and have already started to yield results in Jordan, Egypt and Tunisia. Private investment accounted for nearly 14 percent of the region’s GDP before the recent crisis. The contribution of gross domestic investment to GDP growth reached 4.1 GDP growth points in 2006, more than double its impact in the early 2000s of only 1.3 percentage points. Two additional factors contributing to the recent economic growth have been, first, intra-regional foreign direct investment (FDI) flows that increased not only in the energy and telecommunications sectors but also in sectors such as infrastructure, real estate and tourism. Secondly, greater trade facilitation by reducing tariffs and non-tariff barriers to imports, to the point that the region ranks second — only behind Central Asia — among all developing regions on the number of tariff reforms carried out since 2000. Intra-regional trade in merchandise reached 10 percent in 2004, up from less than seven percent in 2000. Intra-regional tourism nearly doubled in three years, from 22 percent in 1999 to 41 percent in 2002.

Lesson 2: Education not always productive

While the recent employment growth is welcome, it is also worrisome because it indicates that labor productivity, which underpins sustained real wage increases, has not been growing fast. Indeed, the sluggish gains in labor productivity over time suggest that the created jobs have in many instances been low-wage, informal and, importantly, without any real prospects for income growth. In any country, the key for the creation of a productive workforce is to ensure that the education system is teaching the kind of skills that are relevant to today’s global marketplace. Every education system should be teaching basic skills: numeracy, literacy and basic behavioral skills like perseverance, self-discipline and self-confidence. But they should also teach higher order skills such as thinking skills, decision-making skills, teamwork, the ability to negotiate conflict and manage risks, how to apply specific knowledge to real-life situations and specific vocational skills such as foreign languages and information technology. In these areas the regional curricula and teaching methods lag behind international standards.

Lesson 3: Knowledge economy skills needed

As mentioned already above, manufacturing performs poorly in most Arab countries in terms of diversification and value added. With the exception of petrochemicals in the GCC economies, the manufacturing sector is dominated by traditional industries like textiles, clothing and food processing. High-tech industries are virtually nonexistent in Arab countries. Manufacturing exports are dominated by primary products and low value-added goods, mainly fuels, which do not create much employment. Overall, the economies in the region are still biased toward low productivity investments — including in real estate — that have created fewer jobs than are needed to reduce unemployment.

What matters in today’s interdependent world is not how well a country does but how fast it grows relative to others. At present, real per capita income in the MENA economies is growing at nearly 75 percent of the growth rate attained by the developing countries. While this is certainly an improvement compared with 60 percent in the second half of the 1990s, the income gap between the Arab world and other regions is still increasing. To catch up with the rest of the world, the Arab region would need to create four elements: one, an economic and institutional framework that provides incentives for the efficient creation, dissemination and use of knowledge to promote growth and increase welfare; two, an educated and skilled population that can create and use knowledge; three, firms, research centers, universities and other organizations that are capable of tapping into the growing stock of global knowledge, adapting it to local needs, and transforming it into products valued by markets; and four, a dynamic technological infrastructure that facilitates the effective communication, dissemination and processing of information. These four areas form the basis for the construction of the Knowledge Economy Index (KEI). KEI “scores” of some relevant countries show that the region falls below the middle range on the index. It also falls below the scores obtained by OECD countries, most of the transition economies and some East Asian countries. The contribution of education to the overall index has, in many cases, been modest.

Lesson 4: Extensive growth can help

While intensive growth means growth based on more being produced with the same resources, extensive growth means to make more use of unused resources. As already mentioned, the female labor force participation rate in the Arab countries is the lowest in the world. In fact, Arab men also have the lowest participation rate at around 80 percent compared to more than 85 percent in most other regions. Overall, the Arab region has the lowest number of workers in the population. Moreover, despite impressive improvements in education indicators over time and near universal enrollments in primary education in most countries in the region, the percentage of young people who are both out of school and out of work is higher in MENA than in any other developing region.

Lesson 5: Arab economies differ

As argued earlier, high oil prices, the increasing role played by the private sector in the economy, the improvements in the trade regime and the introduction of reforms have all been associated with an acceleration of economic growth and employment in the Arab economies. However, the regional countries are growing at different speeds and each has its own issues to address. For example, labor-abundant countries (such as Jordan, Lebanon, Morocco, Tunisia and even Yemen) are experiencing negative effects from the sharply rising oil import bills, including the fiscal pressure caused by the existence of energy subsidies. Although Jordan recently abolished energy subsidies — and is introducing a compensatory safety net — Syria’s energy subsidy exceeds 10 percent of GDP as it has now become a net importer of fuel. In Yemen, oil subsidies account for nine percent of GDP and its known oil reserves are expected to be depleted within the next decade. Nearly half of all FDI in the region comes from within the region, of which nearly 60 percent comes from the UAE and Saudi Arabia. Although this is a sign of the strength of intra-regional ties, it is also indicative of the Arab region not attracting investment from global investors, except in oil and a very few other activities. Also, while FDI to the region has increased dramatically, it has benefited only a few countries such as Egypt, Tunisia, Morocco and the UAE. Even with respect to trade, tariff protection remains excessive outside the GCC countries, especially among the region’s resource-poor countries, as do other significant constraints to trade such as cumbersome import and export clearing processes. Arab intra-regional trade remains insignificant at around 10 percent of total regional trade, of which 70 percent consists of oil.

The Arab region is attracting little investment from global investors, except in oil

Conclusion

Arab countries are entering the era of the first global financial crisis of the 21st century with different endowments and at different stages of reform. They have financial sectors at various stages of development and varying exposure to the global meltdown. Each country will have to find its own solutions to the problems it faces. But moving away from some wrong beliefs held in the past and understanding better what has worked and what has not in the last decade will certainly help to reduce the impact of the financial crisis on the real economy. The Arab economies can now start focusing more on the substance of education and less on the expenditure. They can make better use of their women and more use of their men. They can support dynamic sectors, such as services, more than romantic ones like manufacturing. They can rely more on the private sector for creating employment and less on the already large public sector. And they can ask their governments to regulate better their banking, financial, capital and stock markets. All of this can help to make their labor markets stronger.

Professor ZAFIRIS TZANNATOS lives in Lebanon and is a former advisor to the World Bank and Chair of the Economics Department at the American University of Beirut.