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(originally published by Booz & Company)


Staying on the Road to Growth

Appeasement vs. Transformation

The most dramatic policy swings have come from governments that try to move in two directions at once: promoting overall economic growth and reform on one hand, while using subsidies to mollify groups and special interests on the other. These efforts naturally tend to work at cross-purposes. Subsidies can often be more popular in the short term, because the gains from economic transformation may not be realized for years, and the social cost can be immediate. For this reason, Middle East governments — even when they have embraced the main planks of economic reform, have achieved some notable results, are convinced that further reform is necessary, and have been schooled in its details — are sometimes less than rigorous in the implementation of reform.

Contrary to many outsiders’ perceptions, the last decade in the Middle East has been one of steady economic expansion. The compound annual real GDP growth rate from 2007 through 2010 was 6 percent in Egypt, 4.2 percent in Tunisia, 6.1 percent in Oman, 16.1 percent in Qatar, and 4.6 percent for the MENA region overall. In comparison, the worldwide economic growth rate was 1.8 percent for the same years. This growth is at least partially attributable to wide-ranging economic reform. Governments have promoted the private sector and trade, made it easier to do business, and created more jobs for women.

But today, many government leaders seem to be recoiling from this agenda. They are seeking refuge in methods of social appeasement — typically increasing subsidies and creating government jobs. Non-GCC states have increased their overall spending by one-third since 2010. In Egypt, subsidies currently account for 10 percent of GDP. The government will spend US$16 billion on energy subsidies in fiscal year 2012, which is 40 percent more than it spent in the previous fiscal year. Tunisia’s transitional government has announced an employment plan that includes 20,000 new public-sector jobs. Since the Arab Spring, the GCC countries have announced that they will pour an estimated $150 billion (12.8 percent of the GCC’s total GDP for 2011) into social welfare, incentive schemes, and higher public-sector wages.

The result is that in an era of high commodity prices, these countries are actually more vulnerable to external shocks. For example, Saudi Arabia’s fiscal break-even price is around $70 per barrel of oil, up from around $50 per barrel in 2008. (The fiscal break-even price is the amount that the government must allocate to its own budget to avoid having to borrow.)

Increasing the size of the public sector would worsen the distortions that helped lead to the Arab Spring. A large public sector crowds out the private sector, removes the incentive for enterprise, and diminishes entrepreneurial dynamism and social mobility. There is also a ratchet effect. Short-term spending becomes a long-term commitment to those who have been rewarded, making the eventual cost of a correction very high.

Nobody expects subsidies to disappear overnight. What is required, however, is a process to ensure that government spending is done in a manner that invests for economic transformation. That means replacing outright subsidies with targeted support to the genuinely needy — buttressed by social dialogue. It also means investing in programs that train job seekers in the skills the economy needs. For example, Saudi Arabia’s Ministry of Labour contracted with the Tamer Group, a private company, to create an institute to attract Saudi nationals and train them in logistics and operations skills. The company typically finds jobs for about 20 percent of its trainees and provides certificates for another third. Another Saudi public–private partnership developed the Madinah Airport, which is critical for transporting pilgrims to this holy city. Constructed by a consortium that included TAV Airports, Air Rajhi Holdings, Saudi Oger, and other companies, the airport is credited with transferring private-sector skill and expertise into the public sector.

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