Arab world economies are generally not very diverse
Economic diversification can be broadly defined as a change toward a more varied structure of production and trade. Internal diversification, also called structural transformation, refers to (1) implementing changes in sectors of production, such as a move toward industry and services and away from agriculture, which accompany economic growth; (2) increasing productivity and upgrading products within existing sectors through the greater use of technology and more efficient methods of production; or (3) creating new services inputs to increasing productivity in agriculture and industry.9 External diversification is a broadening of the range of products and services a country exports, typically moving away from exports of primary goods to higher-value-added goods and services. It can also include broadening export markets.10
Diversification is a broad concept. There are many ways to quantify it, from simple measures such as the number of products and trading partners, to more sophisticated attempts to assess product sophistication (see Box 1 for definitions of concepts employed in this chapter). Data availability also varies and thus constrains which concept can be measured. Trends in diversification in the region across its main dimensions are reviewed below.11
Box 1: Measures of Diversification
There are several ways to measure diversification, including at the regional, country, sector, product, and firm level. This box discusses relevant country- and sector-level methods used in this chapter.
Internal diversification measures sector-level activity, including employment shares and value-added shares, in the agriculture, extractive industries, manufacturing, and service sectors. Structural transformation is the process of changing the composition of economic activity across sectors.1
External diversification measures the composition of a country’s exports. The most straightforward measure of diversification at the country level is the number of exported goods. Export concentration can be measured either through a Herfindahl-Hirschman Index (HHI) score of exported products or a Trade Diversification Index (TDI) measuring country deviation in trade structures from global averages.2 Countries with high values on the TDI, such as Iraq, have very idiosyncratic patterns of trade, typically exporting a very small number of products. Countries with low values, such as France, Germany, and the United States, export a large number of products.
More complex indexes of diversification exist, such as the index of Export Quality and the Economic Complexity Index (ECI).3 These indexes attempt to capture not only the quantity of exported products, but their quality as well. The former measures product quality by estimating a series of equations to capture export prices in destination markets as well as consumer demand for those exports. The latter scales export diversification by the number of countries that export those products. Low values on the ECI represent a small number of exports and/or exports of common products (e.g., agriculture, natural resources). High values, by contrast, represent a large number of exports, including products exported by very few countries (e.g., complex goods). Currently countries that have ECI scores that are well above the average for their income cohort tend to cluster in Asia (in countries such as China, Malaysia, and Singapore), not in the Arab world.
This section examines diversification in the region as well as through key groupings. After a brief look at the extent of structural transformation in the region, it focuses on external and trade-related diversification at the country and sector levels.
Figure 2 shows trends in internal diversification. It plots the average log per capita GDP against GDP shares by sector at the regional level. The x-axis is average log real per capita GDP from 1995 to 2015. Over this period, increases in per capita GDP have been associated with a slight fall in agriculture and manufacturing as a share of GDP. Services have been growing as a share of GDP since 2005, while all other sectors have experienced some decline. Over the period, on average, agriculture amounts to about 7.2 percent of GDP, while manufacturing accounts for roughly 13.6 percent. Services and extractive industries are, by far, the largest sectors at the regional level, accounting on average for 47.7 and 31.6 percent of GDP over the period 1995–2015.
These broad regional trends, however, fail to show major differences across countries. Services make up the largest sector by far, in FCV-affected states and resource-poor countries (Figure 3). Extractives are the largest sector in resource-rich countries, followed by services. In countries impacted by FCV and resource-rich countries, manufacturing accounts for only about 9 percent of GDP. By contrast, manufacturing is the second-largest sector in resource-poor countries and accounts for approximately 17 percent of GDP. This is about the same percentage of manufacturing as seen in successful examples of diversification, such as Chile, Indonesia, Malaysia, and Mexico. Data constraints do not permit further consistent disaggregation on domestic production beyond the broad sector level. By contrast, as shown below, data on trade diversification allow an examination of subregional trends in much greater detail.
Overall, the Arab world’s trends in external diversification have been sluggish for the past few decades. While different measures of diversification produce slightly dissimilar results, at the aggregate level all demonstrate the same approximate trend of little change in levels of diversification. The Arab world’s performance has been much more like the stagnation that has occurred in much of Latin America over the past 40 years than the rising levels of diversification seen in many countries in East Asia over the same time period. In the 1970s, according to the Economic Complexity Index (ECI), for example, the Arab world showed levels of external diversification similar to those in East Asia. Performance on the ECI in these two regions has diverged substantially since then, coinciding with the rapid growth in exports of oil and gas from the Arab world.12 In particular, since 1990, the level of external diversification has been falling steadily in the Arab world and rising rapidly in East Asia according to the ECI. Currently the Arab world has levels of external diversification comparable to those of Latin America and South Asia, while East Asia has levels of external diversification more comparable to Europe and Central Asia (Appendix Figure A.2).
Countries in the Arab world rank about one-half of a standard deviation lower on the ECI than other countries at a similar level of income (Figure 4). Yet this finding masks considerable diversity between groupings of countries. Although resource-rich countries in the region have particularly low levels of diversification for their level of income, they are comparable to those of other natural resource exporters, such as Australia, Azerbaijan, Kazakhstan, and Mongolia. Along the same lines, most resource-poor countries have levels of diversification similar to their middle-income peers, such as Costa Rica, South Africa, and Ukraine.
Patterns also differ within groupings, as shown by country levels of disaggregation. The trend for individual resource-rich countries on the ECI over the past 20 years is one of slight decline followed by recent improvements (Figure 5). Some have made more progress than others: the United Arab Emirates (UAE) made steady progress in becoming more diverse from the early 1990s to about 2010.
Among the countries affected by fragility or conflict in the Arab world, where complete ECI data on diversification are available (Lebanon, Sudan, Syria, and Yemen), Lebanon is by far the most diverse (Figure 6). Yemen and Sudan have become less so over the past two decades. Resource-poor countries are the most diverse economies as a group in the Arab world according to the ECI (Figure 7). Tunisia’s economy has become substantially more diversified over the past 20 years and is now the most diverse among resource-poor countries in the region. Jordan made significant progress in becoming more diversified from about 2000 to about 2010, but has suffered a reversal in this trend over the past few years. Morocco has the lowest ECI score among the region’s resource-poor countries over the past few decades.
The Herfindahl-Hirschman Index (HHI) on export concentration shows steady but slow progress on external diversification for the Arab world overall (Figure 8). Consistent with trends in the ECI, FCV-affected states and resource-rich countries have much lower levels of diversification than resource-poor countries. Egypt, Lebanon, Tunisia, and the UAE have the lowest level of export concentration. Iraq has, by far, the highest level of export concentration, followed by Algeria, Kuwait, Libya, Qatar, and Yemen.
The Trade Diversification Index (TDI) also shows slow but steady convergence toward more diverse economies (Figure 9). As with the ECI and HHI, the TDI shows that resource-poor countries, led by Tunisia, have the most diversified exports compared to other countries in the region. Similarly, FCV-affected states and resource-rich countries, with the exceptions of Lebanon and the UAE, respectively, have far lower levels of export diversification. Egypt, Tunisia, and the UAE have seen the most rapid progress on diversification according to the TDI. Iraq, Libya, and Qatar have seen deteriorating levels of diversification. All other countries have witnessed small, but steady, improvements in their TDI scores over the past two decades.
Although oil and gas remain the region’s dominant exports, data show that a few countries—such as Egypt, Lebanon, Tunisia, Morocco, and the UAE—have managed to initiate and sustain progress in export diversification. Some now have high levels of manufactured and service exports, while others have experienced rapid growth from low bases over the past decade (Figures 10 and 11).
Lebanon is mainly an exporter of services, while manufacturing dominates Tunisia’s export sector. Jordan and Morocco are split relatively evenly across manufacturing and services. The UAE is also developing a comparatively balanced structure of exports between manufacturing and services, especially financial services. Export shares are also changing fairly rapidly among some countries. For example, manufactured exports are growing quickly in Egypt and Bahrain, as well as in Saudi Arabia to a lesser extent. Service export growth has also been very rapid in the UAE over the past decade.
We can further disaggregate changes in export composition by level of skill and value-added (Figures 12 and 13). The World Bank’s Measuring Export Competitiveness (MEC) database shows changes in rates of export growth by product type and level of skill.13 The region’s progress in exporting products that require medium or high skills to manufacture was unimpressive between 2006 and 2016. Morocco and Tunisia are the only countries that experienced more than nominal growth in export rates of either consumer or capital products as well as high and medium skill products. Iraq’s export growth has been in primary exports, while Libya, Syria, and Yemen have experienced very large declines in this sector.
The MEC also contains data on product and trade partner diversification. The latter is called extensive margin diversification and the term for the former is intensive margin diversification. The Arab world has experienced the largest loss in intensive margin diversification since 2006 of any region. Diversification at the extensive margin, by contrast, remained largely unchanged. There are, however, significant differences across countries. For example, Oman and Yemen gained in extensive diversification, while Libya and Tunisia suffered losses in this area. Along the same lines, Algeria, Iraq, Kuwait, Oman, Saudi Arabia, and the UAE experienced losses in intensive diversification, while Syria and Lebanon, to a lesser extent, realized gains in this area.
Further disaggregation by subsector shows some areas of rapid export growth in certain products and countries (Figure 14). Across countries, growth rates have been more than 10 percent in several subsectors, including financial services, transport equipment, automotive products, and professional consulting services. Growth in chemical exports is rapid in Egypt, Morocco, Oman, and Saudi Arabia. Jordan, Qatar, and the UAE are increasing exports of commercial services. Growth rates of machinery and transport equipment in Morocco have also been high.
Overall, data show that diversification remains limited at the region’s aggregate level. Resource-poor countries are the most diverse, with about the same level of diversification as other countries at a similar level of income. Economies in the Arab world’s FCV-affected states and resource-rich countries are far less diverse, by contrast, although the latter have levels of diversification that are similar to resource-rich countries in other regions. Greater disaggregation also shows that, over the 2006–16 period, in some countries double-digit growth rates occurred in several subsectors, such as financial services, transport equipment, automotive products, and professional consulting services. The next section discusses some of the key reasons why progress on greater diversification has been relatively slow in the region.