An Arab World in Critical Need of Economic Diversification
Faleh M. F. E. Alrashidi, Barak D. Hoffman, and Jean Michel N. Marchat, World Bank
For years, countries in the Arab world have faced difficulties in diversifying their economies away from low productivity sectors and exports of fossil fuels toward production and exports of higher-value-added goods and services.1 Although some countries—such as Jordan, Lebanon, Morocco, Egypt, and Tunisia—have been able to diversify their economies to some extent, most countries in the region have struggled.
There are several reasons why these countries would benefit from transforming their economies.
Most importantly, diversification creates jobs and raises growth rates.2 More varied economies have more dynamic private sectors and are better able to move into activities with expanding global demand and to participate in global value chains.3 Creating a more dynamic private sector is especially important since the region faces a major jobs challenge. The current working-age population in the Arab world is growing at about 5 million people per year, but the number of new jobs created is less than half that amount. As a result, unemployment is high and labor force participation is low compared with other regions. The Arab world has especially high rates of youth unemployment and low rates of female labor force participation (Figure 1). Under current policies, the jobs challenge is likely to grow for the foreseeable future. Projections suggest that the working-age population will grow by about 50 percent by 2040—from about 241 million in 2015 to 370 million by 2040.4 To merely maintain current labor force participation and unemployment rates, the region would need to create about 58 million new jobs by 2040; it will need many more if the present situation is to be reversed.
Second, more diverse economies are less volatile.5 Economies dominated by a small number of sectors are highly vulnerable to fluctuations in global demand for those products. Prices of natural resources, in particular, can be especially sensitive to global economic conditions. For many countries in the Arab world, including non-oil exporters, changes in incomes correlate strongly with changes in oil prices.6 Volatility can also lead to large fluctuations in exchange rates, which tends to discourage investment in the tradable sector.
The third reason why countries in the Arab world need to diversify is because hitherto external support systems for the region’s poorer economies—mainly foreign aid and migration to Gulf Cooperation Council (GCC) countries—are becoming increasingly less realistic options.7 Real official development assistance per capita in recent years has fallen by about two-thirds from its height in the mid-1970s (Appendix Figure A.1). Likewise, GCC countries are now increasingly recruiting labor from South Asia, not the region. Migration within the Arab world and the concomitant remittances are consequently a less reliable source of employment and income than they have been in the past.
Creating more diverse economies poses significant challenges for many countries in the Arab world. Education systems are not yet providing the technical and vocational training required to support a dynamic private sector. Along the same lines, needed research and innovation ecosystems are lacking. In addition, the business environment in some countries, especially those affected by fragility, conflict, and violence (FCV), remains challenging. Many obstacles to creating more varied economies in the Arab world have political economy dimensions. For example, despite extensive reforms to encourage private-sector development over the past few decades, favoritism and trade barriers to protect certain sectors still stifle the development of competitive economies in large parts of the region. Likewise, high levels of political instability also deter private investment. This is an especially large challenge in the region’s fragile countries.
There are reasons to be optimistic that the region can overcome challenges that have undermined the success of previous diversification efforts, however. Many countries that have been able to become more diverse over the past few decades—including resource-rich ones such as Chile, Indonesia, Malaysia, and Mexico—faced difficulties similar to those that many countries in the Arab world encounter today. Fragility, conflict, and a history of state control over large parts of the economy did not prevent these countries from implementing successful policies to create more varied economies and dynamic private sectors. Governments in the Arab world can learn from these experiences and tailor those lessons to their own needs and circumstances. In addition, several trends within the region, including significant business environment reforms in some countries, declining levels of oil revenues in others, and rising public pressure for greater economic opportunity suggest that governments may see diversification as a more urgent priority in the future than they have in the past. These trends provide several areas of opportunity to work with governments and the private sector in the Arab world to design and implement policies that encourage diversification.
This chapter provides an overview of diversification in the Arab world and explores options to improve the situation. It is a companion piece to the next chapter on entrepreneurship, which is an important element for diversification and job creation. The next section of this chapter reviews various indicators and trends of diversification in the region. The third section provides a few explanations for the observed trends. The final section provides some recommendations for diversifying the Arab world’s economies by types of countries that exist in the region. Throughout the chapter, when relevant, countries are grouped as resource-rich countries, resource-poor countries, and countries affected by fragility, conflict, and violence (FCV).8