A requiem for the Arab development model.

Malik, Adeel

This article situates recent political turbulence in the Middle East within the long-term failure of the Arab development model that is based on economic controls and welfare concessions. After having sustained generous welfare entitlements for several decades, this development model is coming under increasing strains in the face of a growing and increasingly educated youth population, falling public spending, and an inflexible economic structure. Underpinning this failure is a weak and dependent private sector that survives largely through privileges rather than competition. This failure is most evident in the region's lab or-abundant economies, where privileges are concentrated amongst connected firms but employment is concentrated amongst small, informal sector firms operating at the margins of the economy. I argue that there is a deep trade-off between employment and autonomy; sustainable employment generation is not possible without giving greater autonomy to the private sector and releasing competitive space for its operation. However, private sector development is not simply a question of technocratic policy reform. In a context where economic controls generate rents for insiders and are used to sustain elite coalitions, development has to be conceived as part of a broader political concession.

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Few would dispute that the Arab Spring had clear economic underpinnings. Motivated by the demand for bread, jobs, and justice, the Arab uprisings reflected unmet social and economic aspirations of, among other things, a youthful population. In this article, I argue that the failure of the Arab state to deliver social justice is ultimately rooted in the failure of a development model based on heavy state intervention in the economy and increasingly unsustainable buyouts of local populations through generous welfare entitlements. (1) This "interventionist-redistributive" model of development--typically financed through external rent streams from aid, oil, and remittances--seems to have passed its expiration date. (2) Based on a social contract that trades political acquiescence for welfare distribution, it is primed to produce a failure of expectations. It compromises individual agency, crowds out the genuine private sector, and keeps systems of public finance underdeveloped. The Arab Spring was an indictment of this outdated development model.

Since gaining independence, Arab societies have pursued a development model that is structurally incapable of reconciling aspirations with opportunities. The twin pillars of this system--welfare provision for citizens and privileges for firms--are increasingly in conflict with aspirations for social mobility. While the system offers enough for subsistence, the mobility of both people and firms are restricted. This statist model of development has turned government into a provider of first and last resort, generating an adverse legacy of entitlements that ensures sustenance from cradle to the grave. While the system has expanded access to key entitlements, thereby raising levels of human development, it has trapped educated populations into unproductive jobs and kept social classes dependent and immobilized. With growing claims on state finances, it is no longer possible to accommodate an ever-growing pool of educated unemployed in the public sector. This is creating new "outsiders" to the system. These are the youth, women, and the unconnected, those lacking wasita, or connections, with government and private sector networks. (3) A major crisis of expectations is created for young people who are systematically incentivized to hunt for public sector jobs, turning them away from more competitive, low-wage, and high-effort employment in the private sector.

A similar insider-outsider logic operates in the private sector. If social welfare is maintained through a regime of provision, private economic activity depends on a regime of privileges that allocates economic opportunities through "closed deals" that are restricted to regime insiders. There are few growth opportunities for firms outside the inner circle. Business survives either when it is very close to the state, or very far away. This creates a lopsided distribution of firms, marked by large, politically connected firms at the top of the pyramid and small, informal sector firms at the bottom. As a result, the region suffers from the pathology of the "missing middle"--the absence of productive medium-sized firms that are crucial for job creation. Successful exporting firms that could extend the productive frontier are in similarly short supply. These weak firm dynamics mean that a miniscule portion of small firms graduate to become medium or large firms, having adverse implications for prosperity. (4)

The sustainability of this development model is being called into question by the rising costs of repression and redistribution. (5) Even countries that have traditionally had greater fiscal space to finance welfare provisions--thanks to their abundant resource endowments--are finding it hard to keep pace with growing expenditure commitments. At the current rate of increase in local energy demand, Saudi Arabia will find it very difficult to sustain its welfare regime; indeed, by 2028 energy demand is predicted to increase by 250 percent in Saudi Arabia. (6) Similar fears have recently prompted a Kuwaiti minister of finance to question the country's fiscal sustainability. (7) Rich Gulf states are not only financing the growing needs of their own restive populations, but are also financially supporting neighboring Arab states. For example, Saudi Arabia is effectively subsidizing the social contract of Egypt, Jordan, and Yemen. Without regular cash injections from Saudi Arabia and other Gulf neighbors, these countries will find it especially hard, if not impossible, to finance their generous subsidy regimes. It does not require clairvoyance to predict that this development model is ultimately going to unravel, since it is based on a costly and unsustainable social bargain.

This article summarizes the salient failures of the Arab development model, bringing into sharper focus the comparative role of the state and the private sector and the model's inherent contradictions. The underlying tensions are best reflected in the operation of education and labor markets. While central to explaining the region's long-term development trajectory, the discussion in this article may appear peripheral at a time of unusual turbulence, when the Arab world is passing through its most defining phase since the fall of the Ottoman Empire. Beset with growing violence and social upheaval, it is faced with existential questions that can challenge the very geopolitical make-up of the region.

This makes the focus on development more important, not less. A change in the geopolitics of the Arab world is unlikely to alter the core economic challenges facing the region. A thousand lines can be drawn in the sand to define one nation or another, but this will not alter fundamental economic realities. The issue of youth unemployment will remain, and so will the need to create a new social contract built on a vibrant private sector and a regionally connected market. Enduring peace can only return to the region if the political economy of violence is replaced with that of development.

The remainder of this article is organized as follows: Continuing the discussion on the Arab development model, section two attributes its endurance to the uninterrupted flow of external rent streams. Section three explores the contradictions of human development generated by this model. Finally, section four offers some reflections on shaping a more productive and just social order that better serves the needs of Arab societies.

THE ORIGINAL SIN (8)

A key tension point generated by the Arab development model is the growing mismatch between demography and economic structure. While demography is evolving, with its attendant challenges for labor markets and public services, the region's economic structure remains rigidly incapable of responding to these challenges. Most countries in the region have witnessed a very limited shift in economic structure. The manufacturing sector, which is a primary vehicle for job creation in emerging economies, has witnessed a slow, sometimes even negative, growth rate. (9) Whatever limited structural change the region has witnessed involves a shift from manufacturing to services (largely in government, retail, telecommunications, and banking sectors). (10) While such structural change has sometimes enhanced growth--as in Egypt, for example--productivity in the manufacturing sector itself is generally lower than the rest of the world. (11) With few exceptions, competitive manufacturing oriented towards global markets is largely absent. With the exception of Lebanon and Morocco, the Middle East and North Africa (MENA) region has fewer exporters than predicted for countries with comparative income and size. (12) The region also lacks large exporters that drive export growth and diversification. (13) Such feeble firm dynamics mean that few exporters are able to grow into large global exporters, and there is limited diversification by destinations or products.

In short, manufacturing remains the domain of old well-established actors. Excluding the members of the Gulf Cooperation Council (GCC), MENA countries have some of the lowest proportions of firms entering the formal sector. (14) This is exemplified by Egyptian firms. While politically connected firms in Egypt disproportionately benefit from energy subsidies and bank credit, they tend to operate in sectors that rely more intensively on capital than labor. Thus, despite benefiting from state patronage, these firms rarely act as the engines of employment creation. Evidence from a large sample of Egyptian firms in 2010 shows that politically-connected businesses accounted for 60 percent of net profits and 92 percent of loans, but only 11 percent of employment. (15) The refuge for the unemployed is usually the informal sector, which absorbs a large proportion of the labor force in labor-abundant Arab economies. (16)

This makes for a precarious employment strategy, especially when the state's role as the employer of first resort is rapidly shrinking. Egypt provides a dramatic illustration of this employment emergency. Evidence from household surveys suggests that while the share of government wageworkers has witnessed a precipitous decline since 1970, this slack was mainly picked up by the informal sector, whose share rose from roughly 4 percent to above 40 percent. (17) Formal private sector employment actually fell during this period (see Figure 1). These painful labor market dynamics partly explain why a strong constituency for private sector development has failed to take root. With small informal firms and the public sector acting as the mainstay of employment, it is hardly surprising that there are few stakeholders for private sector development.

[FIGURE 1 OMITTED]

Despite being one of the largest employers, the informal sector has limited capacity for collective organization. This marginalized segment of the economy probably harbors the same negative opinion about the private sector as many ordinary Arabs. Such perception emanates from a systematic and institutionalized discrimination reflected in a key policy anomaly: While employment is concentrated in small firms, privileges are concentrated among large connected firms. Although the private sector is arguably more developed in the resource-rich Gulf, it has yet to become an "autonomous" political force. (18) Segmented labor markets set the limits for the private sector's independence. Maintaining a perverse division of labor, these segmented labor markets define two separate employment regimes: one for nationals who are primarily absorbed in the public sector and the other for migrants who end up in private sector jobs. This is politically expedient. The United Arab Emirates (UAE), for example, forecloses all avenues for class-based politics, offering an important reason why economic diversification in the country is palatable since it poses little political threat. (19) Politics is also crucial for explaining the content and quality of economic reform in Arab countries. Described as "uneven, hesitant[,] and incomplete," economic reform was politically neutralized through a selective economic opening that bypassed crucial sectors of the economy, and left intact pernicious non-tariff barriers. (20) Rather than widening economic access, economic reform simply re-configured political power.

The economic and political inertia generated by this development model is maintained through an uninterrupted flow of external rents. As a resource-rich region par excellence, more than 80 percent of total merchandise exports in many Arab countries consist of oil and gas. (21) Dependence on hydrocarbons is so pervasive that even in economies considered to be resource-poor, such as Syria and Yemen, oil dominates the exports (the ratio of fuel exports to total exports, averaged over the period 1962-2008, is 63 percent in Syria, 34 percent in Egypt, and 21 percent in Tunisia). (22) While the role of hydrocarbons in sustaining the Arab social contract is well-stated in the academic discourse, rents from foreign aid and remittances can play a similarly important role.

The role of foreign aid is best exemplified through the experience of Egypt and Jordan. Egypt's fiscal order is unlikely to survive without regular cash injections from oil-rich states in the Gulf. Jordan is a similarly important beneficiary of strategic rents; total grants and loan guarantees are estimated to reach $2.5 billion in 2014. (23) In fact, the average Arab state derives greater aid rents than the average low-income country or than a state in sub-Saharan Africa. Over the last fifty years, the MENA region received roughly three times more net aid per capita than Latin America. (24) Rents from oil and aid are complemented by remittances from migrant labor. When compared with other developing regions, MENA countries have the highest ratio of remittances to GDP. (25) Together with other external rents, they extend the fiscal comfort zone, delay economic reforms, and exacerbate the region's moral hazard problem. Because of this, the Arab world seems trapped in a rent curse, not just a resource curse. Reliance on these unearned income streams constitutes the "original sin" of Arab economies. In the next section, I discuss the key development contradictions associated with this model.

CONTRADICTIONS OF HUMAN DEVELOPMENT

The Arab development model is not just a legacy of failure. Welfare entitlements generated by this model have expanded education and health facilities, helped to reduce poverty and inequality, and shielded citizens from some of the worst economic shocks. However, these ostensible improvements in human development are ultimately self-undermining, since they entail a difficult trade-off between entitlements and citizen empowerment. As political instruments emanating from an authoritarian bargain, welfare entitlements create an enduring tension between quantitative gains in human development and deeper human freedoms. They support a precarious balance of human development that enhances access but undermines agency, expands consumption possibilities but impairs human capabilities.

These contradictions in human development--a legacy of the region's lopsided development strategy--are the subject of this section. I begin by synthesizing the Arab world's mixed record of human development and finish by highlighting its intrinsic challenges.

A REMARKABLE CATCH-UP

Arab countries have converged over time to higher levels of human development. (26) Impressive progress has been achieved in expanding access to education, health, life expectancy, and nutrition. This is no small achievement, especially given the low levels of human development inherited by Arab countries some fifty years ago. In 1970, there were large gaps between Arab countries and their respective comparators in education. By 2006, MENA countries were able to catch up--and in some cases even surpass--the levels achieved by similar regions. In comparison to much of the world, Arab countries have experienced faster growth in educational attainments. (27)

Similar progress is noticeable on aggregate measures of human development. In 1990, low-income countries in the Arab world did not fare much better than sub-Saharan Africa on the Human Development Index (HDI), but by 2007, they managed to surpass many developing nations. The middle- and high-income Arab countries were similarly successful in closing their HDI gap with other comparators. (28) Thanks to such progress, of the top ten countries that made the most impressive strides in human development during the last forty years, five were from the Arab world. (29)

Public expenditures are favorably disposed towards social sectors. The average Arab state spends a greater proportion of its GDP on education than other developing countries. In terms of expenditures on social protection, the Arab world spends twice as much as Eastern Europe and sub-Saharan Africa. (30) In many Arab countries, social protection expenditures constitute the single largest component of public spending. (31) Arab states have performed reasonably well on measures of distribution, growth, and income. In terms of level and growth of real GDP per capita, the Arab world has done better than South Asia, Latin America, and Southern Europe but has lagged behind the more prosperous East Asian countries. The region fares even better on commonly used indicators of poverty and income distribution. Extreme poverty impacts a smaller proportion of the population in the MENA region when compared to other developing countries (for example, the World Bank Headcount estimate for 2011 was only 1.69 compared to 46.81 in sub-Saharan Africa and 24.50 in South Asia). (32) Even with $2 a day, only 12 percent of the population in Arab countries lies below the poverty line. (33) Levels of income inequality are relatively modest, with Gini coefficients ranging between 0.32 and 0.41. (34)

To summarize, existing evidence on the incidence of poverty and inequality suggests at least four salient features. First, the Arab world has one of the lowest incidences of poverty among developing countries. Second, measured income inequality remains relatively modest in the region, as mentioned above. Third, the poorest quintile of the population has witnessed a significant increase in income. In fact, it is one of the few regions that has witnessed falling levels of income inequality in recent decades. Fourth, these gains have been achieved with relatively low levels of economic growth. (35) Some of these ostensibly favorable trends are partly rooted in the specific initial conditions, such as an early introduction of land reforms and the absence of well-developed hereditary nobility.

These achievements--even if admittedly quantitative at this stage--are sometimes under-appreciated. A rising number of educated youth, many of them females, has led to a powerful new constituency for social change. Unlike Western Europe, where new sources of income generation have led to the emergence of class-based struggles that widened political access, the MENA region has witnessed no fundamental shift in its economic structure. Instead, it is witnessing a truly generational struggle for inclusion, in which young, educated entrants to labor markets are demanding a more inclusive and participatory social order. At the same time, the Arab world has rapidly urbanized: more than 50 percent of its population now resides in urban areas. (36)

There is considerable evidence to suggest that Arab countries have done rather well when it comes to basic entitlements for human development. However, progress on human development is mainly the result of a welfare regime that is part of a wider system of rent distribution. Thus, the region faces many enduring challenges to development, some of which are discussed below.

A VARIABLE RECORD

Any evaluation of Arab development should begin with a sobering admission of the considerable variation in human development across regions, income groups, and generations. In a region with an otherwise respectable education record, there are persistent pockets of illiteracy in Egypt, Iraq, and Yemen, which contain nearly three-quarters of the total illiterate youth in the region. Although nearly 96 percent of the fifteen to twenty-four year-old cohort is literate in the Arab world, 49 percent of Moroccan youth are neither in school nor in the workforce. (37) While the region cannot be characterized as low-income by any standard, there is a wide variation in income levels. For example, high-income countries in the region are some of the richest in the world, whereas low-income countries such as Sudan and Yemen are also some of the poorest.

QUALITY AND PRODUCTIVITY OF EDUCATION

Quantitative access to education and health aside, the region faces a major quality challenge. Current systems of education in the region fail on multiple fronts. A particular shortcoming relates to the failure to instill critical thinking. Arab students perform poorly on internationally standardized mathematics tests. The percent of eighth graders performing "below low" in MENA is 54 percent, more than twice the international median. (38) The result is that the educated cohort is often not only unemployed but also unemployable. Education systems in the region have produced a regime of credentials rather than skills, the result being that despite the growing pool of educated unemployed, the private sector routinely complains about the shortage of skills. There is a serious mismatch between the education provided by universities and the skills demanded by the private sector. Both the provision and demand for vocational education is lacking. In a milieu where most new entrants into the labor market want to take up white-collar managerial jobs, technical education lacks the prestige that could put it on par with mainstream education. Voluntary unemployment is rife, which produces long spells of unemployment. Additionally, despite having expanded access to education, female labor force participation is the lowest in the developing world. (39) Taken together, this means that education is not very productive in Arab countries. This is borne out by empirical evidence that demonstrates a negative correlation between education and growth in Arab countries. (40) While education is to be justified for its intrinsic value, the relatively low productivity of Arab education systems compared to other developing countries presents an enduring development challenge.

THE DEMOGRAPHIC CHALLENGE

Population growth in the Arab world has surpassed other regions. This population surge is partly driven by a significant decline in child mortality and the slow onset of fertility decline. It is predicted that fifteen to twenty-four year-olds will soon constitute around 20 percent of the population, which will remain the case until 2025. These population pressures have resulted in youth bulges and, in the absence of any structural economic change, severe imbalances in the labor market. The region suffers from one of the highest rates of youth unemployment in the world (youth unemployment is twice as high as in South Asia, which also has a high percentage of young people in the population). (41)

ACTUAL VERSUS MEASURED INEQUALITY

Although Arab countries have had lower initial levels of inequality upon their independences, many countries display a growing divide in income and mobility, especially in the wake of economic liberalization. Poverty and inequality are more visible on the ground than in statistics. While measured inequality is relatively low, anecdotal evidence indicates a persistent income divide even in otherwise oil-rich countries, such as Algeria and Saudi Arabia. In Tunisia, the urban-rural divide is both deep and persistent. Lurking behind these divisions is the challenge of measurement. A genuine concern is that political incumbents have a strong incentive to exclude these pockets of poverty from household data. The top tier of the income distribution is widely believed to be excluded from household surveys. Governments in the region have long imposed controls over the dissemination of sensitive information that could pose a possible challenge to the regime. The sensitivity around issues of poverty and inequality has prevented the emergence of robust data reporting systems. Nationally representative household surveys are available only for a handful of countries: Egypt, Morocco, Jordan, Syria, Tunisia, and Yemen. Even when available, household data is difficult to disaggregate by region, and there is usually inconsistency between data from household surveys and national accounts. (42)

INEQUALITY OF ACCESS

Perhaps a more daunting challenge relates to the inequality of access to growth opportunities that is neither well-measured nor adequately analyzed. With few exceptions, Arab countries do not suffer from some of the harshest challenges of human survival, such as those afflicting countries in sub-Saharan Africa, including extreme malnutrition, complete lack of a social safety net, and prevalence of controllable diseases. However, people and firms in the Arab world have unequal access to growth opportunities. There is a particularly sharp inequality of opportunity between the young and old. The playing field is uneven in several domains, generating disparities between urban and rural milieus, public and private sectors, citizens and non-citizens, old and young individuals, and connected and unconnected firms (to the government or those with political influence). (43)

TRADITIONAL MEASURES OF WELL-BEING

These measures are unlikely to capture the scale and depth of poverty and deprivation. The sanguine scenario painted by official data is often belied by surveys of public perceptions that highlight high levels of dissatisfaction with public service delivery. (44) This underscores the need to look beyond narrower, relatively crude dimensions of well being. Multi-dimensional indices that consider broader dimensions of education, health, and standard of living reveal a more nuanced picture of the citizenry's well-being. In Yemen, only 17.5 percent of people can be characterized as falling below the $1.25-a-day poverty line, but a significantly higher proportion (nearly 53 percent) is considered as multi-dimensionally poor. A similar divergence is evident in Morocco, where 11 percent of people are multi-dimensionally poor, which is about four times higher than the proportion below the $1.25-a-day poverty line. (45) Statistics on child nutrition offer another alternative evaluative tool, since the nutritional status of children under five can provide important clues about vulnerability. Yemen has the highest proportion of stunted children. In terms of its effects on child nutrition, growth in Arab countries is not particularly pro-poor. (46) When compared with other developing countries, agricultural growth in MENA is also not especially pro-poor. Manufacturing and service-led growth, on the other hand, has a more favorable effect on poverty. This is understandable given the limited scope for agricultural development and the greater presence of the poor in the informal sector. (47)

Traditional measures of well-being also fail to capture other sources of vulnerability; prominent amongst these are the perennial concerns of water scarcity and food insecurity. As one of the most food-deficient regions in the world, Arab countries and their economies are mostly dependent on food imports for meeting their consumption needs. Countries with more abundant populations and relatively limited oil revenues are thus more vulnerable to food price shocks. Yemen faces alarming levels of food insecurity, as do other states such as Egypt, Jordan, Lebanon, Morocco, and Sudan. (48)

THE DISTRIBUTIVE CHALLENGE

Unlike countries with high resource rents per capita, such as Kuwait and Qatar, where distributing resource revenues to small populations is manageable, the labor-abundant economies of the region face a formidable distributive challenge. Most Arab governments dedicate a sizeable chunk of their resources to providing subsidies on fuel and food. In Egypt and Syria, more than 20 percent of public spending is directed towards such provisions. In some cases, the subsidy expense exceeds the spending on social protection. As relatively blunt instruments, subsidies raise concerns of efficiency and equity. Apart from causing market distortions and burdening public finances, subsidies are often poorly targeted (90 percent of the subsidies in Egypt benefit the top 20 percent of the population). Evidence suggests that social sector spending--particularly, on education--is half as effective in the Arab world as in other developing countries. (49)

The above discussion offers just a few contradictions associated with the Arab development model. While it has generated limited gains in human development, creating a false sense of prosperity, these gains are not translated into productivity and growth. The political inertia sustained by this distributive regime also poses serious questions about the long-term sustainability of this model. Beyond the realm of narrowly defined measures of development, the region lacks broader freedoms that expand human capabilities. The freedoms of assembly and speech are often restricted, and business associations are usually empty shells that strengthen vertical control structures rather than horizontal linkages among firms. Ordinary people are merely passive recipients of state handouts; rarely do they act as active stakeholders and participants in governance. In light of these deficiencies, the next section deliberates on a new logic of reform to redefine the citizen-state relationship in the Arab world.

A NEW LOGIC FOR ECONOMIC REFORM

The Arab world needs a new logic for reform that visualizes an economic order that is competitive, egalitarian, and rooted in the specific cultural realities of the Arab world. One reason why earlier reform efforts--whether democratization or economic liberalization--failed was that they did not widen access to the system beyond narrow clienteles tied to the regime. Prior experience from the developing world underscores the connection between economic and political reforms. Neither can be attempted on their own. Consider three major reform episodes over the last 200 years. The Tanzimat reforms, carried out under the Ottomans between 1839 and 1876, delivered large-scale bureaucratic re-organization. The second set of reforms, introduced by early nationalist leaders, such as Egypt's Gamel Abdel Nasser, sought greater control of the state over economic resources through land reforms and nationalization of the private sector. The third reform episode represents the period of limited economic opening under Anwar Sadat and Hosni Mubarak. While the tone and tenor of these three reform experiences are different, they are part of the same institutional continuum--in that, in each case reform was a centralizing instrument. Carried out under whatever guise, reform simply refurbished the power of state elites. (50)

The objective principle of future reform should therefore be to bring individuals and firms from the economic margins to the mainstream. The region needs a new development model where welfare distribution and economic prosperity do not lie at opposing ends of the spectrum. Rather than exclusively focusing on neoliberal economic reforms, which are both maligned and contested in contemporary Arab societies, a broad-ranging discussion should be initiated on creating an "open-access order" that expands opportunities for ordinary people, creates a level playing field for firms, and generates new ladders for economic and social mobility. With its emphasis on access, rents, and violence, the discourse developed by Douglass North and other colleagues offers a possible conceptual entry point into imagining innovative ideas. (51)

Since the post-Arab Spring fall of autocrats in Egypt, Libya, and Tunisia, progress towards democracy has often been equated with the holding of multi-party elections. In hindsight, this rush to elections without building state capacity and bargaining structures was ill-advised. Reinforcing existing rentier structures, it intensified distributional struggles and converted many Arab states from centralized fiefdoms to localized domains of extraction (regions currently controlled by the rebel groups provide an apt example). Institutional analysis offers a relevant lesson here--it is relatively easier to remove the central figurehead than to dislodge the elite coalition that feeds off the rentier structure. (52) The Arab world needs strong bargaining structures, which are difficult to imagine without independent income streams. With large parts of society still dependent on the state for salaries and subsidies, the narrative for change is as problematic as that of the status quo, since it is predicated on a revival of the old Nasserite social contract that was a problem to begin with. (53)

Genuine political change is unlikely as long as Arab society remains immobilized and dependent on the state. The crux of institutional reform in the MENA region lies in a fundamental redefinition of the ruler-merchant relationship that concedes a competitive economic space to the private sector and generates independent sources of income. Private sector development is at once the "most despised as well as the most desirable aspect of reform." (54) It is the most despised aspect, since the private sector is simply seen as an appendage of the state. Markets, in the Arab psyche, serve more as a medium of monopolistic distribution than competitive exchange. At the same time, it is the most desirable aspect of reform, since without a strong private sector, no durable solution to the region's gigantic employment challenge can be found. The Arab public space has long been torn between the binary distinctions of the state and the market. It is important to transcend this false divide, since a stronger private sector requires an even stronger state capacity.

While private sector development has remained a priority in policy papers, the narrative has continued to be largely technocratic, focusing on bureaucratic and regulatory barriers to business and ignoring the difficult politics of private sector development. I argue below that rulers need to give at least two concessions for creating an independent merchant class: the removal of barriers to domestic and regional trade.

THE POLITICS OF POLICY

Arab rulers have traditionally preserved social order by distributing unproductive rents to ruling elites. These rents consist not only of externally derived revenues from oil and aid, but politically mediated rents from economic controls, licenses, and monopolies. The pervasive non-tariff barriers in the Arab world are not just procedural or economic barriers but also political instruments for structuring elite relationships. Controls, interventions, and subversion of markets are means of co-opting key socioeconomic groups and managing political alliances. A recent study shows that firms associated with the Ben Ali clan in Tunisia were more likely to operate in sectors that required prior government authorization and with restrictions on foreign entry. (55) In Egypt, 71 percent of politically connected firms were protected by at least three non-tariff measures compared to 4 percent of all other firms. (56) That these relatively invisible trade barriers served an important political function is one reason why they have survived periods of economic liberalization.

The interests of governing coalitions have proved more enduring than the force of ideology. Whether the socialism of the 1960s and 1970s or the neoliberal economic reform of the 1990s, the system of vertical control, discretion, and privilege has proved to be resilient to all ideological flavors. The Middle East remains one of the most protected regions in the world, where the movement of capital, goods, and people are subjected to severe restrictions. The behind-the-border barriers that generate trade frictions are more pervasive in the Arab world than even sub-Saharan Africa. As the Arab world has become more centralized it has also become more fragmented, resulting in multiple coordination failures and severe loss of economic potential. All across the Arab world, a labyrinth of regulations and procedures that privilege insiders encumbers economic systems.

These trade frictions effectively translate into a regime of economic repression, erecting entry barriers for aspiring firms and restricting the mobility of small firms. A worryingly small number of new businesses are registered in the region as a result. The average MENA firm is ten years older than its Eastern European counterpart--a damning indictment of a predatory system that preserves the advantage of incumbency. As essential elements of the Schumpeterian process of creative destruction, such limited entry and exit of firms reveals a depressing picture of firm dynamics. Even in countries with relatively active private sectors--such as Morocco and Tunisia--less than 5 percent of small firms were able to graduate to large firms over a ten-year period. The probability that a manufacturing or mining firm with twenty to fourty-nine employees will have more than fifty employees four years later is higher in Turkey than in Egypt or Morocco. (57)

Mobility of firms is restricted through vicious entry barriers, wherein a lack of financial access plays a role. Only about 8 percent of total lending is directed towards small and medium enterprises in the MENA region. (58) Unconnected firms--businesses that benefit little from direct state entitlements--are pushed to the margins, swelling the size of the informal sector. Even in Morocco, a country with a strong merchant elite, the informal economy accounts for 44 percent of GDP. (59) The logic of growth in the informal economy is different. Here, firms grow by proliferating into many small firms. Empowering firms in the informal domain is crucial for dealing with crony capitalism, since young and growing firms on the margins are the best antidote to the power of incumbency, as they serve as a competitive challenge to established firms. But, before designing effective policy reform, it is important to conduct a political economy mapping of the informal sector. Analysis of the business-state relationship has often focused on the upper segment of business hierarchy. Even the small and medium enterprises (SME) category is far too aggregate: firms in different size distributions may be located at different ends of the political economy spectrum.

REGIONAL ECONOMIC COMMONS

With a centralized state structure and, in many cases, a weak, non-existent constituency of merchants, private sector development is doubly challenging in the Middle East. Twenty years ago, Eastern Europe suffered a similar dilemma: it had a strong state and few stakeholders for an independent private sector. But if it was able to bypass this adverse legacy, it was in large measure due to its integration with European markets. In fact, without access to European markets, the political and economic transition of Eastern Europe would have remained incomplete. In the same way, the recent political opening in the Middle East--no matter how limited and fractured--is difficult to consolidate without regional market access. The foundations for new politics need to be laid through a radical transformation of existing trade relations, which helps to create a durable constituency of merchants. This is not possible without strong horizontal linkages within and across Arab societies.

Larger regional markets are an important prerequisite for a thriving private sector. But Arab economies remain fragmented into isolated and weakly connected geographic units. Because of this, trade between Arab nations is a paltry 12 percent of total trade. (60) Apart from denying scale economies to firms, fragmented Arab markets prevent deep trade reforms and the formation of regional supply chains. This leads to the under-provision of regional public goods. A connective regional infrastructure that expands markets, reduces trade costs, and cultivates efficient supplier relationships is one such public good. While the GCC countries are undertaking huge investments in regional infrastructure, such connections are poorly developed elsewhere in the region. Ongoing conflict is destroying even these weak regional linkages, scaling up the cost of needed infrastructural investments in the Arab region by $250 billion.

There is a strong domestic and broader geo-political logic behind this persistent economic fragmentation. As argued before, divided markets serve the interests of political insiders by giving them control over rent streams that are crucial for sustaining elite coalitions. Thin markets preserve the monopoly powers of insiders and increase the returns to predation. By maintaining the hegemony of regional and global powers, fragmented markets also support an adverse geo-political equilibrium. Existing trade orientation in the Middle East is still driven by old colonial imperatives, where trade relations between many North African states and their former French colonial masters are often stronger than their economic ties with neighboring states.

While Arab leaders have signed numerous regional trade initiatives, most of these remain merely stated intentions. The reason for this is that liberalization of regional trade requires important political concessions that Arab elites are not yet prepared to give. The fates of Arab economies are interlinked, and, ultimately, serious progress on addressing the core challenges of diversification, private sector development, and job creation will be difficult without mainstreaming the agenda for regional economic cooperation. Considering the resistance to regional cooperation, integration with global markets is often presented by international donors, such as the World Bank and IMF, as a panacea for the region's economic ills. While regional and global trade are not mutually exclusive, weakly connected Arab markets reduce the quality of their engagement with forces of globalization. In fact, I would argue that the Arab world cannot effectively globalize unless it regionalizes first.

FOCUS ON ELITE INCENTIVES

A strong private sector is unlikely to be borne out of a technocratic policy choice. It is likely to be the outcome of a political concession. It is therefore important to initiate a debate not just on the attributes, direction, and nature of reforms, but also on elite incentives and how they can be aligned with economic welfare. Underdevelopment--both its existence and persistence--is usually tied to the manner in which elites resolve underlying conflicts over the distribution of resources. Rarely has any transformation taken place from poverty to prosperity and from a rentier to a developmental state without compatible elite incentives. (61) This raises the question: When do elites favor a significant opening up of the economic and political system? The literature on institutional change suggests that elites often agree to widen access when faced with an existential threat.

CONCLUSION

Beyond the headlines generated by the Arab uprisings in 2011, the story of the Arab Spring is also the story of a failed development model--a model based on a large interventionist state and a weak private sector. Underneath this model lies a fundamental tension between aspirations and opportunities. Even as generous welfare entitlements have expanded access to education, the rentier economic structure has failed to produce matching job opportunities. In many of MENA's labor-abundant economies (such as Egypt and Tunisia), a fast-shrinking resource pool means that the public sector can accommodate fewer workers. Such erosion of the welfare state has fueled a middle class "grievance." (62) The space vacated by this withdrawal of the state has not been filled by the private sector, which continues to survive through privilege rather than competition. Across most Arab economies, the private sector remains dependent on state patronage.

While private sector development is crucial for job creation, it is not simply an outcome of policy choices aimed at improving the climate for investment and reducing the cost of doing business. Creating an autonomous private sector is also a political and regional challenge. Given that independent sources of income can pose a long-term threat to rulers, they are feared rather than favored. The procedural barriers that create economic enclaves for insiders are therefore also political barriers, since the rents generated by such restrictions are used to manage ruling coalitions.

Private sector development is also a regional challenge, since divided markets prevent firms from reaping economies of scale. All crises, whether economic or political, also contain the seeds for creative destruction. The 2011 Arab revolts had created precisely such an opportunity for change. Unfortunately, rather than redefining the Arab political economy in favor of its people, continuing turmoil in the region has cast a long shadow of uncertainty, underscoring how the choices of Arab elites are diametrically opposed to the imperatives of development. Rather than financing regional development, rich GCC states are investing in regional violence through support of rebel groups. But this moment of conflict can only delay fundamental challenges, not solve them. Already, there is a growing realization that the status quo is unsustainable and that governance systems need to be more responsive to citizens. There is less clarity, however, on the nature of strategic concessions required from Arab elites. As noted in this article, there is desirability for two key concessions: relieving competitive space for independent merchants and eliminating barriers to regional trade.

NOTES

(1) The analysis in this article is restricted to Arab states (except Djibouti) included in the World Bank classification of Middle East and North Africa.

(2) Tarik M. Yousef, "Development, Growth and Policy Reform in the Middle East and North Africa since 1950," Journal of Economic Perspectives 18, no. 3 (Summer 2004), 91-116.

(3) Ragui Assaad, "Making sense of Arab labor markets: the enduring legacy of dualism," IZA Journal of Labor and Development 3, no. 6 (25 April 2014), http://www.izajold.eom/content/3/1/6.

(4) Marc Schiffbauer et al., "Jobs or Privileges: unleashing the employment potential of the Middle East and North Africa" (World Bank, Washington, DC: 2014), 39-62.

(5) Adeel Malik and Bassem Awadallah, "The Economics of the Arab Spring," World Development 45, (2013), 296-313.

(6) Kate Mackenzie, "Saudi Arabia's oil exports warning," Financial Times (blog), 29 April 2010, http://blogs.ft.com/energy-source/2010/04/29/saudi-arabias-warning-about-its-oilexports/#axzz3Go888rrb.

(7) Sylvia Westall, "Subsides draining Kuwait's state budget-minister," Reuters, 30 April 2014, http:// www.reuters.com/article/2014/04/30/kuwait-economy-idUSL6N0NM2K320140430.

(8) The description draws on my earlier work, Malik and Awadallah, 297.

(9) Schiffbauer et al., 7-38.

(10) Ibid.

(11) Syria and Jordan are partial exceptions to this. For related evidence see Schiffbauer.

(12) Caroline Freund and Martha Denisse Pierola, "Export Superstars" (World Bank, Washington, DC: 2014).

(13) Ibid.

(14) Entry density represents the number of newly registered limited liability firms per 1,000 working-age people (those between ages fifteen and sixty-four). Leora Klapper and Inessa Love, "The Impact of Business Environment Reforms on New Firm Registration," (World Bank, Washington, DC: 2011).

(15) Ishac Diwan, Philip Keefer, and Marc Schiffbauer, "The Effect of Cronyism on Private Sector Growth in Egypt," (Harvard Kennedy School, Cambridge, MA: 2013).

(16) Assaad, 11.

(17) Assaad, 13.

(18) Steffen Hertog, Giacomo Luciani and Marc Valeri, eds., Business Politics in the Middle East, (London: Hurst Publishers, 2013).

(19) Michael Herb, "A Nation of Bureaucrats: Political Participation and Economic Diversification in Kuwait and the United Arab Emirates," International Journal of Middle East Studies," 41, no. 3 (August 2009), 375-395.

(20) Yousef, 99.

(21) "World Development Indicators 2013" (World Bank, Washington, DC: 2013).

(22) Ibid.

(23) Steven Simon, "How Vulnerable is Jordan?," Middle East Institute, 5 August 2014, http://www.mei.edu/content/at/how-vulnerable-jordan.

(24) Despite containing a significantly greater proportion of the world's poor, South Asia received only $6 per capita in net foreign assistance during the last decade compared to $43 per capita in MENA. See World Development Indicators 2013.

(25) Ibid.

(26) Available evidence points towards a mixed record of human development in the Arab world. The region displays a middling performance on human development: It is neither among the worst performers nor the best achieving regions. Performance also depends on who we compare the region with. Rauch and Kostyshak (2009) divide the Arab world into countries that are (a) in sub-Saharan Africa (b) fuel endowed and (c) in a residual category, and contrast them with other comparators in the respective categories. This reveals a relatively favorable comparison on indicators of health, education, and income. For example, by 2006 Arab countries in sub-Saharan Africa had a higher life expectancy than other countries in the region. Similarly, Arab fuel-endowed economies had done better on this count than fuel-rich countries in the non-Arab sample. For a more detailed analysis, see James Rauch and Scott Kostyshak, "The Three Arab Worlds," Journal of Economic Perspectives 23, no. 3 (2009), 165-188.

(27) Assaad, 1.

(28) Djavad Salehi-Isfahani, "Human Development in the Middle East and North Africa," (Human Development Research Paper 2010/26, UNDP, New York: 2010).

(29) Francisco R. Rodriguez and Emma Samman, "The North African Miracle," UNDP, 2010.

(30) "Statistics of Public Expenditure for Economic Development," International Food Policy Research Institute (IFPRI), (Online Database: 2011). http://www.ifpri.org/book-39/ourwork/programs/ priorities-public-investment/speed-database.

(31) Ibid.

(32) World Bank, "Regional Aggregation Using 2005 PPP and $1.25/day Poverty Line," http://iresearch.worldbank.org/PovcalNet/index. htm?1.

(33) Ibid.

(34) Sami Bibi and Mustapha Nabli, "Income Inequality in the Arab Region: Data and Measurement, Patterns and Trends," Middle East Development Journal, 1, no. 2, (2009), 275-314.

(35) Ibid.

(36) World Development Indicators 2013.

(37) Clemens Breisinger et al., "Beyond the Arab Awakening: Policies and Investments for Poverty Reduction and Food Security" (IFPRI, Washington, DC: 2012).

(38) "International Mathematics Report: Findings from IEA's Trends in International Mathematics and Science Study at the Fourth and Eighth Grades," Trends in International Mathematics and Science Study, (International Association for the Evaluation of Educational Achievement, Amsterdam: 2007); Assaad.

(39) This can be caused by several factors, one of which is the distorting influence of oil on labor markets. For the detailed argument, see Michael Ross, "Oil, Islam and Women," American Political Science Review 102, no. 1 (February 2008), 107-123.

(40) Breisinger et al., 27.

(41) Farzaneh Roudi-Fahimi and Mary Mederios Kent, "Challenges and Opportunities--The Population of the Middle East and North Africa," (Population Reference Bureau, Washington, DC: 2007); Assaad.

(42) Bibi and Nabli.

(43) Recent research has provided evidence of inequality of opportunity in education. In Jordan, for example, there is limited intergenerational mobility, suggesting a strong link between the education of parents and children. A summary of evidence is available at: http://erfblog.org/2014/06/08/recentresearch-on- inequality-of-opportunity-in-the-middle-east/.

(44) Breisinger et al.

(45) Ibid.

(46) Ibid.

(47) As Breisinger et al. show: "Regression analyses further show that, unlike in the rest of the world, manufacturing- and service sector-led growth, rather than agriculture-led growth, is most pro-poor in Arab countries" (viii).

(48) IFPRI (2011).

(49) Breisinger et al.

(50) Malik and Awadallah, 296-313.

(51) Douglass North, John Wallis, and Barry Weingast, Violence and Social Orders: A New Conceptual Framework for Interpreting Recorded Human History (Cambridge, England: Cambridge University Press, 2009).

(52) Ibid.

(53) This is often used to refer to the generous social welfare package provided by early nationalist governments in the Arab world. In the 1950s the Arab state instituted extensive welfare entitlements, ranging from the provision of education, health and job opportunities (mainly in the public sector). This was also combined with food and fuel subsidies.

(54) Malik and Awadallah, 296-313.

(55) World Bank (2014).

(56) Diwan, Keefer, and Schiffbauer.

(57) World Bank (2014), 18.

(58) Roberto Rocha and Subika Farazi, "The Status of Bank Lending to SMEs in the Middle East and North Africa Region," All About Finance (blog), 28 July 2010, http://blogs.worldbank.org/allaboutfinance/the-status-of- bank-lending-to-smes-in-the-middle-east-and-north-africa-region.

(59) Masood Ahmed, "Bringing the Informal Sector into the Fold," iMFdirect, 16 November 2011, http://blog-imfdirect.imf.org/2011/ll/16/bringing-the-informal-sector-into-the-fold/.

(60) World Development Indicators 2013.

(61) North, Wallis, and Weingast, 148-187.

(62) Melani Cammett and Ishac Diwan, "Toward a Political Economy of the Arab Uprisings," in A Political Economy of the Middle East, 3rd ed. (Boulder, Colorado: Westview Press, 2013).

Adeel Malik is the Globe Fellow in the Economies of Muslim Societies at the Oxford Centre for Islamic Studies and an associate professor of development economics at the University of Oxford. Email: adeel.malik&qeh.ox.ac.uk.