Economic integration tendencies in the Middle East (2)

by Nasser M. Suleiman
(Ph.D. student in Hungary researching economic integration in Arab countries)

Until recent years, when several Mena countries began to make efforts to liberalize trade and implement more open trading policies, the main characteristics of the trade system in these countries were high rates of protection, lack of transparency, and distortions. The economies remained relatively closed. What are the causes behind the Mena region’s generally disappointing performance on trade reform and the limited success with intra-regional integration?

The indicators of limited economic interaction mentioned contrast sharply with the repeated efforts made by governments to implement cooperation agreements among groups of countries in the region, and with the region’s economic, geographical, and cultural affinities.

As in other regions, there were three reasons behind most attempts at regional integration: (i) economic welfare gains, (ii) enhanced collective political bargaining power in extra-regional affairs; and (iii) non-economic national goals (especially, security-related ones). On paper, these reasons should be facilitated by economic, geographical, and cultural conditions that are conducive to regional integration in Mena.

This section explores the rationale behind the potential for gains from greater regional interactions and the means of attaining them. The region requires economic-policy changes, most of which are also required if the region is to benefit from the globalization and integration of the international economic system. Indeed, Mena will attain a higher level of regional economic interaction simply by implementing the policies needed to benefit from the changes in the world economy. It is also argued in this paper that pursuit of Mena integration within the overall context of multilateral, externally oriented policies will bring further growth to the region. However, political factors are likely to constrain the pace of integration over the next few years. Indeed, European experience confirms that such plans need time to develop.

Box 2. Mena's integration potentials

On the economic side, the region has diverse natural, human, and financial endowments that are spread among countries in the region. The regional market offers considerable purchasing power, and there are indicators of trade-creating gains.

On the geographical front, the region covers a large, contiguous land mass rich in diverse natural resources (oil, gas, non-fuel minerals, agriculture pockets, etc.) On paper at least, regional trade routes are relatively accessible.

On the cultural front, the extent of language and religious coherence compares favourably with other regions such as the EU and Asean.

Mena’s overall economic performance in recent years has fallen short of the potential. Per capita income has stagnated, investment and domestic saving rates are low, and the productivity of investment has been disappointing. An insufficiently diversified economic base makes the region extremely vulnerable to external shocks. The economic and financial challenges are compounded by high unemployment, rising entry into the labour force and poor social indicators.

As already noted, most countries in Mena will continue to trade mainly outside the region, primarily with Europe, the United States, and Asia. However, the volume and share of regional trade could rise significantly. This is the main reason for believing that there will be substantial economic gains from greater regional integration. [6]

There is a wide diversity in the factor endowments within Mena, most strikingly in labour and natural resources, as well as differences in the extent of economic diversification. [7] Much of the trade within the region is based on this diversity, with oil the main traded commodity and labour the main traded factor. Closer regional integration is unlikely to lead to much trade diversion in these commodities, but it should promote greater merchandise trading in other commodities. Apart from its effects on merchandise trade, regional integration would boost service flows and intra-regional investment. Mena residents hold a large share of their portfolios outside the region, with estimates of the total ranging from USD 350 billion to USD 600 billion. Given the right economic policies in recipient countries, even a small reallocation of portfolios in favour of regional activities would make a big difference to the region’s resource base for investment.

It would encourage the right policies if the regional integration efforts were to include attempts to develop an investment code conforming to the highest international standards and practices. There would also be gains from policy harmonization, especially in reducing the cost of the currently proliferating competitive tax exemptions and concessions, which undermine the tax base.

Recent progress towards an Arab-Israeli peace agreement provides an opportunity for moving towards greater political coherence within the region and some direct economic benefits. Peace will permit gradual reductions in military spending, which is the highest in the world in terms of GDP share. [8] It should also increase the returns on investment, by reducing country risk and opening up regional projects in areas such as power generation, tourism, and water management. Peace also makes it more likely that countries will be able to agree on measures to promote or facilitate intra-regional private-sector economic activities.

However, some qualifications must be added. (i) Overcoming the legacy of recent history will take time. The length of time will depend on the perceived nature and dividend of the peace arrangements and the institutional support they receive. (ii) The Arab-Israeli conflict is only one, albeit the most important political conflict and uncertainty facing the Mena countries. (iii) The scope for regional integration may be undermined by real or imagined perceptions that there will be unequal allocations of the gains and losses associated with regional integration. Already there is concern in the region that Israel will become economically dominant and contribute to the deindustrialization of other countries, or at least retard their industrialization processes. In fact, it is more likely that the relative importance of Israel in the regional economy will decline, while other countries, further from the technology frontier, grow more rapidly.

Given the current outlook for the region, the policy implications of the analysis here is not that countries in the region should give economic-policy priority to embarking on the complex process of creating an EU or Nafta-type arrangement. Each country should focus first on domestic economic-policy reform, and secondly on the associated process of integrating into the world economy through multilateral trade and payments liberalization. Successful liberalization will then promote regional interaction.

It is critical to continue with structural reforms aimed at deregulating and liberalizing the Mena economies, some of which are among the most protected in the world, as noted earlier. High tariff and non-tariff barriers have denied consumers access to world-quality goods and reduced the efficiency and responsiveness of the production sectors in several Mena economies. To be sustainable and effective, liberalization of the external trade and payments regimes will need to be accompanied by appropriately tight macroeconomic policies and concurrent progress on domestic structural reforms, particularly those affecting investment and the labour and financial markets.

The process of integration among the Mena economies will be strengthened if strong trading ties are developed with major partners outside the region, e.g. free-trade arrangements with the United States and the EU. The EU’s Mediterranean Basin Initiative contains incentives not only for closer economic ties between EU countries on the one hand and those in the southern and eastern Mediterranean on the other, but also among the latter. Although the liberalization schedule under these agreements is spread over 12 years and full liberalization does not apply to agriculture, the stimulus to regional integration may be very important.

Domestic reforms and multilateral liberalization will be the main engines of greater Mena economic integration, but there is also a need for measures aimed directly at regional interaction. These include reducing divergences in regulatory frameworks (including customs nomenclatures), improving road and rail transport and facilities for moving goods between countries, enhancing other communications, and developing facilities for regional export financing. These measures should be harmonized as far as possible with the best international standards and practices. Several studies point to significant opportunities for regional projects that promise high returns. These include electricity generation (particularly better links between power grids within the region), water management, and tourism.

The absence of an advanced infrastructure to connect the Arab countries has profoundly detrimental consequences for inter-Arab trade and tourism. Any discussion of Arab economic integration that fails to acknowledge this remains theoretical, and cannot advance until the necessary infrastructure developments are in place. Such developments include a complete overhaul and updating of maritime, land, and air routes. It is also imperative to integrate electricity, telecommunications, and information networks, since economic progress has become increasingly dependent on access to advanced information technologies.

In maritime shipping, a number of major ports need developing, to improve handling capabilities and capacities. Several ports in the Arab world are perfectly situated to act as a crossroads between Europe and the Mena region. With improved rail links between North African countries, the hinterland of the region’s ports can be considerably extended, and ports of Tunisia, Libya, and Algeria come to serve as transit points for considerable volumes of Arab-European trade.

With Egypt, which lies at the meeting point between the Maghreb and the Mashreq, there are several ports, including Port Said, Safaga, Suez, and Alexandria, that could be developed into important storage and transit centres for trade between the Maghreb and the Mashreq, and between both and Europe, North America, South-East Asia, and East Africa.

The ports of Jeddah and Yanbaa on the Arabian peninsula could play an important role in linking North Africa with the Gulf. Aden also has potential as a storage and transit station for trade between North Africa, the Gulf, and South and East Asia. It could also play a role in trade between the Gulf and Iraq on the one hand and East Africa, Europe, and the Americas on the other. As for Dubai and Abu Dhabi, they are well positioned as storage and transit centres for trade between the Gulf, Iraq, and Iran and North Africa, Europe, East Asia, and the Americas.

Beirut was once the Arab world’s pre-eminent centre of trade. Now that the Lebanese civil war has ended, it can again assume an important role in trade between the Mashreq, the Gulf, Europe, and North America. The same applies to the Syrian ports of Latakia and Tartous. For these ports to realize their full potential in stimulating inter-Arab trade and Arab trade further afield requires a level of coordination and reorganization capable of allowing the region’s ports to act as dynamic transportation centres.

It is also essential to the region’s economic prospects to develop the overland transportation networks. Egyptian proposals presented at last year’s Mena III Cairo Summit constitute a blueprint for this. Upgrading the 7000-km road from the Moroccan city of Oyoun, on the westernmost extremity of the Maghreb, through Algeria, Tunisia and Libya to Cairo will cost an estimated USD 850 million. The Egyptian stretch has already been completed. What remains is to develop the rest into a four-lane highway.

Egypt’s central position, with road links between Cairo and Gaza via El-Arish and via Nuweiba or Taba and Aqaba, to Amman, Syria, Lebanon, and Turkey, could be enhanced by building a suspension bridge across the Tiran Straits, linking Ras Nusrani in Egypt to Ras Hamid in Saudi Arabia. The 15.6-km bridge would cost USD 3.6 billion and take about five years to build. Despite the huge cost of the project, its realization would represent a great leap in the region’s infrastructure. Should the necessary finance for the project not be forthcoming, the only other option would be to upgrade and modernize ferry services between Egypt and Saudi Arabia.

Developing an integrated and coherent inter-Arab infrastructure is essential in encouraging increased volumes of trade and in allowing Arab producers an edge in international markets. And its political dividends are likely to be as great as the economic benefits, dispelling misunderstandings as the Arab world becomes, in the end, a single, integrated socio-economic entity.

Such direct regional cooperation would be furthered by creating an appropriate institutional framework. There is a need for a forum in which countries from the region can meet to discuss regional economic problems and work to develop solutions to them. This organization might be similar to the Oecd, in emphasizing policy coordination and discussion, but extend also to having a policy-research staff dedicated to finding solutions to the problems and plans that emerge from discussions among policy-makers. There is also a need for regional public projects involving more than one country, and for financial and informational assistance to develop the private sector. These are essentially the functions of the proposed Middle East Bank, in which several regional and non-regional countries have already expressed interest in subscribing to 75 per cent of the shares.