Reformative process in the market and state in Yemen

by Mohammed al-Maitami

Associate Professor of Economics, Sana'a University
Visiting Scholar, University of California, Berkeley

IT IS probably necessary to begin by restating the most basic principle of macroeconomics which says that the political, social and military fate of any nation depends greatly upon its economic success. Today there is no area of economics more vital to a nation's success than its macroeconomic equilibrium and macroeconomic performance.

It is also necessary to restate the most basic tenet of the institutional economics, which says that a functioning national market cannot exist without a modern and strong state - without effective legal, administrative, and regulatory institutions, maintained by the state.

We all have seen the overall deterioration in all aspects of economic and social life before implementation of the Economic Reform Program (ERP). The rate of real GDP growth was minus 0.2%, core inflation 75%, budget deficit 17% of GDP, account balance minus 12% of GDP, GDP per capita $265, unemployment 25%, population below the poverty line 21%, dramatic fluctuation of Yemen currency from 30 R/D to 140-160 R/D.

Since 1995 the Yemeni government began to implement a large-scale program of reform. The program was formulated in cooperation with the IMF and the World Bank and it is considered a liberal program aimed at making the market the dominant regulator of the economy.

Unfortunately, the outcome of this reform is not encouraging even though 1995 and 1996 were nominally successful years for the program. Any shocks have reversed previous optimistic expectations and revealed the underlying weaknesses of the program. The ERP program has put the cart before the horse.

Of course, there are objective and subjective determinants of the current situation. In terms of the objective determinants, we may include the economic backwardness of the country, scarcity of human capital, capital and technology. Also we could include the international economic situation, particularly the present Asian economic crisis, which directly effects the Yemeni economy. For example, oil revenue has decreased to roughly 30% of 1997's level and the budget deficit has risen this year to 13% because 95% of Yemeni exports are oil products, and 76% of Yemeni exports go to southwest Asian countries.

In the subjective factors we initially include the absence of a modern and strong state. Lawlessness, corruption and bribery are widespread in Yemeni institutions and this poses a major obstacle to any corrective program and more generally to any development program in Yemen.

All economic and social indicators point to the impeding of the Economic Reform Program, in spite of the achieved successes in the fields of monetary and fiscal reform in 1995 and 1996. Even those successes have dissipated in the years of 1997 and 1998 as a result of first external shock.

Let us look in brief at the main economic indicators, which were the subject of the reformative process: real GDP growth, the rate of inflation, budget deficit, national account balance, the coefficient of investment. What do these indicators show us?

  • The real GDP growth increased from minus 0.2% in 1994 to 5.1% and 4.3% in 1995 and 1996. But it fell again to 3.6% and 2.5% in 1997 and 1998.

  • Core inflation fell from 75% in 1994 to 20%, 10% and 5% in 1995, 1996 and 1997 respectively, but it rose again to 55% in 1998.

  • The budget deficit as percentage of GDP was reduced from 17% in 1994 to 6%, 4%, and 2% 1995, 1996 and 1997 respectively. Currently it is rising again to 12%.

  • The deficit in the national account balance fell from -11.6% in 1994 to -10,1%, 3,5%. -1,5% in 1995,1996, and 1997 respectively, but it is rising again to -10.0% in 1998.

  • The exchange rate rose from 125-130 R/D the average designed level drawn by program to 148 R/D this year.

  • Investment coefficient is more than four times less than planned.

  • The standard of living is falling according to UN sources. GDP per capita is less than $240.

  • Unemployment is more than 35%.

  • The percentage of the population living under the poverty line is more than 50%.

  • The majority of infrastructure is deteriorating rapidly.

  • We are witnessing the growing collapse of Yemeni national industry. More than 30 firms were closed within the last two years, more than 5,000 industrial workers were fired.

  • The main sector in Yemen - agriculture - produced only 13% of GDP, while 56% of the labor force is concentrated in this area.

There are in my view two major factors standing behind the impeding of the ERP: First, the fragility of the Yemeni state and administrative anarchy. Second, theoretical weaknesses in the design of the ERP. I am not going to focus my presentation on the first factor. There are possibly others who will address this factor. I'd prefer to concentrate a little bit on the second factor. No doubt that without reforms the Yemeni people would be in far worse condition. There is also no doubt, that our people have faced far greater hardship than the current hardship resulting from the implementation of the reform program. These are facts with which it is difficult to argue.

At the beginning of reformative process there were some positive results which we have previously mentioned. Those achievements were realized initially with financial support from abroad. But the main goals of growth and sustainable development (real GDP in material sectors, Coefficient of investment, unemployment) remain static. The question of investment has not made any significant progress. Investment is a principle condition for growth and the lack of investment in Yemen has been due to the lack of an appropriate environment for investments. The FIAS report for Yemen of June 1997 stated that "… constrained public budget, low income level, decentralized population and difficult physical environment; under-developed legal system and weak institutional capacity; under-developed local capital markets; and (most critically) Yemen's high political risk rating, as well as....(the fact that) the state, the government of Yemen is still viewed as weak, unreliable and lacking credibility."

At the first external shock these achievements disappeared, because of lack of cohesion of the program. The architects of the economic reform program assumed that the problems of the Yemeni economy consisted primarily of government deficits, negative balance of payments, sharp fluctuations in the value of the Yemeni Rial and the existence of an inefficient and unproductive public sector.

Based upon these assumptions the economic reform program anticipated that simply relieving the pressure on the balance of payments, reducing the government deficit through cutting expenditure and cutting government subsidies, making social services cost effective and privatizing the public sector would achieve domestic accord and general economic equilibrium. The program assumes that simply freeing market forces from government regulation and closing inefficient public sector businesses will allow these market forces to mobilize and establish the proper levels of investment, production, consumption, importation and exports in light of current resource endowments. The program ignores that the deeper roots of the economic crisis which are not restricted to financial and monetary policy, but rather these are merely symptoms on the surface of more fundamental and ongoing contradictions and difficulties in the material production and administrative-political management.

The question arises today: is it possible for the market to operate effectively in the absence of the state or even in its presence, but in a weak and fragile condition? The answer to this question comes from the World Bank itself in the statements made in the report of the World Bank in its yearly meeting held in Hong Kong on 23-26 September, 1997: "In the absence of an effective state it is impossible to produce any economic or social progress... and without protection from theft and violence and repressive behavior by the state and without a fair judiciary which is able to enforce its rulings, it is difficult for markets to grow and develop."

The final address by James Wolfensohn, President of the World Bank Group, to the Board of Governors of the World Bank Group, at the Joint Annual Discussion on 6-8 October, 1998, confirms our belief that any economic reforms and measures "... if they do not fight corruption and put in place good governance, if they do not introduce social safety nets, if they not have the social and political consensus for reform, if they do not bring their people with them, their development is endangered and will not last."

Prepared for delivery at the annual meeting of the Middle East Studies Association, Chicago, USA, December 1998.