The competitiveness agenda for the Arab world in a new economic context
Although oil prices have been at historic highs during the past decade, only some of the oil-exporting Arab countries have fully taken advantage of this opportunity to make appropriate investments and implement reforms to foster diversification, efficient allocation of resources, and innovation. Today the Arab world is facing a number of challenges stemming both from global trends and from idiosyncratic issues that pertain specifically to the region. In light of this context and of its current competitiveness landscape, the region needs to focus on a number of key long-term objectives through policies that can ensure broad-based economic progress.
According to the Global Risk Perception Survey conducted by the World Economic Forum in both 2016 and 2017 across different stakeholder groups and areas of expertise, the world will be affected the most in the next 10 years by five key trends: rising income and wealth disparity, increasing polarization of societies, rising cyber dependency, changing climate, and aging population. The same survey also identifies the causal connections between those trends and the potential risks that could materialize globally.
While trends are global in nature, not all countries and regions will be exposed to their consequences with the same intensity and pace. With one of the youngest populations in the world, the Arab countries are unlikely to be affected by the negative consequences of an aging population in the near term. In contrast, the other four trends are likely to influence the region’s prospects.
The results from the Global Risk Perception Survey respondents’ assessment to the relevance of global trends and their interconnections with potential risks were linked to the perceptions of executives in the Arab countries of how worrisome those same risks are for the future of their businesses, based on the results of the Executive Opinion Survey conducted yearly by the World Economic Forum. This exercise produces an estimate of the impact of trends on businesses that takes into account the degree of concern among the business community in each country about selected risks and weighs it by the extent to which those risks are driven by the global trends selected.8
Since 2016, rising income and wealth disparity has been the trend with the most worrisome consequences according to the Arab business community, followed by increasing polarization of societies and rising cyber dependency, which has overtaken changing climate this year (Figure 6). Income inequality is particularly relevant in resource-poor countries, but tops all other trends across all subgroups. Concern about the consequences of rising cyber dependency has increased across the region, but especially in resource-rich economies, where it became the trend with the second-highest impact coefficient. In the past year, there has been a general decrease in the level of concern about consequences of income inequality and polarization of societies. While this can be attributed to a natural adjustment in business priorities in light of improved stability in many Arab countries, focus on building more inclusive and cohesive societies should remain strong.
In spite of a decrease in the coefficient since 2016, Tunisia remains the country where rising income inequality and wealth disparities might have the strongest impact. Morocco and Oman follow together with Algeria, the only Arab country where concern about the consequences of rising income and wealth disparities increased (Figure 7).
Executives across most of the region show their concern about long-term unemployment or underemployment (56 percent of Jordanian businesses), profound social instability (40 percent of Tunisian businesses), and failure of national governance (38 percent of Algerian businesses). At the other end of the spectrum, businesses in countries such as Qatar and the United Arab Emirates (UAE) are less worried about the consequences of increased inequality.
Closely linked to income inequality, the growing polarization of societies is also poised to affect the region in the future since it exacerbates the risk of social instability and failure of national governance. Concern about polarization of societies has lessened in most countries, with the exceptions of Morocco, Algeria, Jordan, and Qatar.
The concern about the consequences of cyber dependency has increased dramatically in resource-rich economies, making this trend the one with the third highest potential impact on the region. Not surprisingly, cyber dependency is raising more concerns in those countries where ICTs have developed more and a failure of critical information infrastructure or a cyberattack could have larger effects. In the UAE, half of companies are worried about cyberattacks (up from about 30 percent in 2016) and one in five (it was one out of ten in 2016) sees data fraud as one of the risks of major concern. Large increases in concern were also observed in Bahrain and Saudi Arabia.
The level of concern about the consequences of climate change has also decreased in most of the region; this concern is greater in those countries that are less likely to successfully adapt to climate change and its consequences because their environmental and geographic conditions are more fragile. Forty-four percent of businesses in Jordan and 36 percent in Qatar are worried about water crises, with both countries having experienced shortages in recent years; for the second year, they remain the ones in the region with the highest level of concern about climate change. Kuwait, Tunisia, and the UAE all experienced sizeable increases in concern.
In addition to the consequences of these global trends, the region faces specific risks that are more directly linked to its economic and competitiveness structure. The recent fall in oil prices has uncovered once again the risks associated with excessive dependence on raw materials and a lack of economic diversification. Countries in the region have been forced to take measures to stabilize fiscal budgets, privatize national assets, and facilitate private-sector development outside of the oil and mining industries.
Yet in 2017 40 percent of businesses in the UAE were concerned about energy price shocks; in Kuwait this was 42 percent; in Algeria, 44 percent; in Egypt, 45 percent; in Saudi Arabia, 46 percent; and in Qatar, 51 percent. Closely linked to oil price shocks, fiscal crises were also on the watch list of executives in the region, staying high in the minds of 34 percent of them in Saudi Arabia, 40 percent in Bahrain, 42 percent in Kuwait, 54 percent in Egypt, and 73 percent in Algeria. Finally, asset bubbles fueled by excessive and unsustainable investment of oil revenues in previous years concerned 39 percent of executives in Qatar, 43 percent in Kuwait, and 51 percent in the UAE.
How are the Arab countries equipped today to address these challenges? How can improving the region’s competitiveness help ensure that the right solutions are found?
As illustrated so far in this chapter, the Arab world is comprised of a diverse set of economies at different stages of development and with different strengths and weaknesses. However, there are some areas where the lag with OECD countries is generally bigger and common across most countries in the region. On one hand, in spite of improvements in some of the region’s leading countries, innovation and technological readiness are still the two pillars where the gap is biggest. On the other hand, the conundrum of policies and factors that relate to higher education and training and labor market efficiency and that contribute to the region’s high levels of unemployment should be addressed (Figure 8).
On the basis of the information outlined so far, Figure 9 helps to identify four key challenges to address in the medium to long term. These deeply interlinked challenges are discussed in detail below.
Transitioning away from natural resources and diversifying the economy
Fluctuations in energy prices are not new, and the Arab world—especially in its most resource-rich economies—has been adapting to the ups and downs these fluctuations have caused to its economy (Figure 10). In 2015, oil rents amounted to about 15 percent of GDP in resource-rich economies, with peaks of 38 percent in Kuwait and 23 percent in Saudi Arabia. Four years earlier, those percentages were twice as high: 31 percent in oil-rich countries, 60 percent in Kuwait, and 49 percent in Saudi Arabia. Over the past 25 years, only in 1998 were these figures lower, but 20 years ago the rebound was quick. Most observers estimate that this time lower prices for natural resources are here to stay as global demand for energy products is shifting toward cleaner sources, giving to this challenge a much stronger sense of urgency than in the past.
Many countries in the region have adopted diversification plans and other economic strategies, often focusing on a number of key sectors including finance, logistics, tourism and tech-based services, and manufacturing. Yet successes have been limited in most cases because a number of key obstacles remain.
Energy subsidies are still high in most Arab countries, leading to economic distortions that favor industries that make intense use of capital and energy rather than labor. In 2011, implicit and explicit energy subsidies accounted for as much as 10 percent of GDP in Egypt, Algeria, and Saudi Arabia and surpassed public expenditure on education in all of the Arab countries except for Morocco and Tunisia.9 Energy subsidies not only create distortions to the economy but disproportionately benefit the most affluent portion of the population. Forced by budgetary restrictions, most Arab countries have approved reform programs to reduce energy subsidies in recent years. The success of the long-term implementation of these reforms will depend on the capacity of governments to inform the population about the magnitude and implications of current subsidies, use savings from subsidies for socially and economically meaningful expenditures, and resist pressures by organized interest groups.
Diversification of the economy is also hindered by the lack of workers with the right set of skills. There is a scarcity of local graduates in technical and scientific subjects as well as students from vocational training programs, and especially in resource-rich countries domestic workers are less inclined to take jobs in the private sector (more on this below). Many Arab countries (especially in the GCC) have had recourse to foreign workers to fill this gap, but this model has a number of shortcomings.
First, most countries have not been able to attract qualified foreign talent to work in technical positions outside of the oil and gas industry, with a few exceptions—such as finance and other advanced service sectors in the UAE. In addition to legal restrictions, labor conditions and differences in remuneration across sectors, especially for foreign workers, might be driving this. In 2009, manufacturing wages in Saudi Arabia were approximately three times higher for Saudis than for foreigners.10
Second, many legal restrictions still prevent foreign workers from being employed in some sectors or functions, from moving freely in and out of the country, and from switching employers. These restrictions create frictions in the allocation of talent to more advanced sectors.11
Unfortunately, in recent years many governments have been implementing additional restrictions on foreign workers in the form of increased visa fees, larger quotas for nationals, and outright bans in some sectors. The two-year flexible work permit (Flexi Permit) implemented by Bahrain represents a positive exception and a step in the right direction. The scheme allows, under certain conditions, expatriates to reside and work in the country for a renewable period of two years without a sponsor; they are thus able to choose one or multiple employers (see Box 1).12
Economic diversification is also slowed by the absence of a thriving private sector in most Arab countries. The rise of private entrepreneurship has been weighed down by the specific history and development path of many Arab countries, and continues to be hindered today by a series of policies, restrictions, and economic conditions. The next section discusses this issue in detail.
Box 1: The Flexi Permit: Bahrain Explores a Labor Market without Kafala
Ausamah Alabsi, The Labour Market Regulatory Authority, Kingdom of Bahrain
The sponsorship system—or Kafala as it is known in the Middle East—was devised in the early 1960s to address labor shortages in economies that were evolving as a result of their new-found wealth. The first shortages were those of skills, where workers did not have the required expertise. By the 1980s the shortages were in numbers of workers; at the time, the Gulf states had reached full employment yet needed a larger workforce.
The sponsorship system was devised to manage the influx of needed workers. On one hand the system appealed to society’s conservative side by making the employer responsible for the migrant. It also ensured that the newcomers had real jobs that required their presence—thus making the employer responsible for the migrants’ entry into the country and for the administrative control of the new demographic.
The principal regulations of Kafala stipulated that migrants would work only for their own sponsor—they could not leave the job without the sponsor’s consent. This stipulation, along with its social, legal, and human side effects—is the most well-known aspect of the sponsorship system. Less well known is that the system further stipulates that the sponsor himself could not hire a migrant who was not under his sponsorship—that is, the sponsor was prohibited from hiring a migrant who was in the country under the sponsorship of a different employer. A sponsor who did hire someone in violation of this regulation risked heavy legal and financial penalties. In a labor market comprised of at least 80 percent imported labor, that is a big restriction.
This system continued for six decades, creating a labor market that was easy for a migrant to enter but difficult to move within. The shortcomings of the imbalanced labor relationship that Kafala produces are widely discussed and criticized, and their remaining severity depends on the extent of reform that has been attempted over the years from country to country.
In the last decade the new phenomenon of economic inflexibility has manifested itself. From the employer’s perspective, the rigidity of Kafala meant that businesses were not able to address a sudden need, avail themselves of a market opportunity, or satisfy a short-term contract without going through the administrative process of applying for a permit, sourcing the workers, and flying them in. The sponsorship system also meant that a law-abiding business would have to pay for a full-time wage even if the job was part-time.
The Kafala restrictions may have been tolerable in the economic structures of the 1970s and 1980s, but in the fast-moving economies of the 21st century they are a heavy burden slowing down growth. The regulatory inability to satisfy demand for casual, temporary, or short-term labor resulted in a gray market that supplied the workers needed, albeit illegally. And, like all gray markets working outside the law, the system produced its own spin on rights and human infringements.
Realizing this, Bahrain launched a new scheme to manage expatriate labor that eliminated the sponsor, dubbed the Flexi Permit. This scheme—the first of its kind in the region, perhaps globally—categorizes the migrant permit holder as “Self-Employed” with a permit and residency that allows him or her to work in any occupation and at any skill level, with any employer or number of concurrent employers, on a short- or long-term basis, full or part-time. This permit is issued for two years and renewable indefinitely. The Flexi Permit has no restrictions, and no quid-pro-quos or provisos. It signifies a paradigm shift in addressing labor market inefficiencies and improving flexibility in migration management.
The Flexi Permit, launched in July 2017, automatically provides medical insurance and allows free movement and travel. For now it is a sizable pilot program that aims to attract 48,000 permit holders, equivalent to 8 percent of the migrant labor force. Several thousands of migrant workers are already making use of this new system.
The program empowers the worker, gives flexibility to the market, and addresses all the historic shortcomings of a legacy system that has outlived its economic and social relevance in the age of Uber.
Increasing the role of the private sector and diminishing the state’s intervention in the markets
The public sector still represents a large share of the economy in most Arab countries, either directly or through state-owned enterprises, especially in the oil and gas industry. The private-sector, non-oil economy represented less than 30 percent of GDP in Kuwait in 2014, while the shares in Oman, Qatar, and Saudi Arabia were all below 50 percent (Figure 11). As mentioned above, insufficient private entrepreneurship has been identified as one of the obstacles to the diversification of the region’s economy and more generally as a source of potential distortions.
Why does private-sector development lag behind in the Arab world? In many countries, inadequate legal frameworks and a lack of policy stability discourage private-sector investments, especially from abroad. According to the World Bank’s Doing Business indicators, the Arab countries are among the worst performers globally when it comes to protecting minority shareholders. Policy instability also creates an unfavorable environment for private investors in many countries in the region. According to the World Economic Forum’s Executive Opinion Survey, policy instability was among the top five most problematic factors for business in seven of the eleven Arab countries covered in 2017: Egypt (1st, the most problematic factor); Jordan and Tunisia (3rd most problematic); Algeria and Saudi Arabia (4th); and Kuwait and Lebanon (5th).13
Public employees are granted disproportionately generous benefits, which discourage employment in the private sector among nationals. Public jobs often enjoy wages that are twice as high as those in most private industries and require shorter working hours. In spite of the fiscal crisis due to the oil price slumps, attempts to cut benefits and perks for public employees have often failed or have later been repealed as a result of rising discontent among the affected cohorts. Governments have often taken direct or indirect measures to reserve these public employment jobs for national workers. The Government of Saudi Arabia is among those that stepped in most strongly, first pledging to remove all expatriate workers from the public sector by 2020 and then reserving certain job categories in the private sector for national workers only.14 This problem is compounded by a lack of entrepreneurial role models and a widespread culture of risk aversion that highly values the security of public jobs. Already today, the great majority of public employees is constituted by nationals in many Arab countries, especially the resource-rich ones: 50 percent in Qatar, 67 percent in Bahrain, 85 percent in Kuwait, and 99 percent in Saudi Arabia. Domestic workers are generally concentrated also in other sectors with a high degree of public ownership (education, utilities, health, and finance) but are present to a lower degree in labor-intensive private-sector activities such as manufacturing (Figure 12).
The shortcomings of local financial markets—which are generally unable to fund new projects or small- and medium-sized enterprises (SMEs)—also explain the delay in private-sector development in Arab countries. These shortcomings are further addressed below when discussing the need for more modern forms of financing for innovation.
Ensuring opportunities for the youth and the workforce of the future
The share of people aged 15–24 in the Arab world peaked in 2005 at 21 percent (Figure 13). In the course of the current century, the region’s population is expected to double to almost 700 million people, but longer life expectancy will drive a lot of this trend and the share of youth population is set to slowly decrease. The current years therefore are those when Arab countries could potentially enjoy the benefit of a young, dynamic, and increasingly educated workforce. Yet this opportunity is being missed because the region grapples with low labor force participation and high unemployment rates among its youth.
Data on youth not in education, employment, or training (NEET) are available for only a few Arab countries, but provide an indication of the extent of the problem: in 2015 16.1 percent of young people aged 15–24 were idle and unemployed in Saudi Arabia; 21.2 percent in Algeria, 27.6 in Egypt, and 44.8 in Yemen (in 2014).15 Available data on youth unemployment and labor force participation confirm this picture (Figure 14). There is an almost linear relationship between youth unemployment and the size of the youth cohort: in countries with younger populations the youth are relatively more unemployed. The most notable case is Jordan, where people aged 15–24 represent approximately one-third of the working age (15–64) population, but almost half of those who are actually participating in the labor force remain un-employed (Figure 14). Youth participation itself is low and generally cannot be attributed to enrollment in educational and training programs. This, along with the low participation of women across all ages, exacerbates the loss of talent in these countries (less than 20 percent of women participate in the workforce in Algeria, Jordan, and Yemen).
Although tackling this problem will require a number of measures and reforms for factors ranging from education and the labor market to entrepreneurship and access to credit, none is likely to succeed without a shift in the cultural paradigm that places a higher emphasis on the role of youth in society, the importance of merit-based opportunities, and the value of work as a way to advance social and economic emancipation. As explained in the previous section, resource-rich countries have long granted to their nationals gilded benefits and positions in the public sector, thus reducing the incentive for their youth to work toward their own professional careers. Youth are also discouraged by the widespread perception that connections (wasta in Arabic) are the best way to land to a good job. This is partially due to the nature of the economic system and the weight of state-owned enterprises (among the large firms) and family-owned business (among the smaller and informal businesses), but also to the limited role of formal labor intermediation as a solution to information asymmetries.
The lack of merit-based opportunities appears in the differences of youth unemployment rates by level of education, which also reflects the mismatch between skills and fields of education (especially for advanced degrees) and the needs of the labor market. There are no consistent data for all Arab countries, but available evidence shows that higher education does not turn into more job opportunities. Unemployment is as high as 60 percent in Saudi Arabia and 50 percent in Egypt among youth with advanced degrees (Figure 15). Although the level of unemployment varies across countries, more education is consistently associated with a higher incidence of jobless youth. In addition to the factors outlined above, which relate to the structure of the economic system and the nature of the labor market in many Arab countries, this association of education with joblessness could also be due to societal preferences that tend to place higher importance on fields of education that are not directly applicable in private-sector positions, with all the countries shown in Figure 15 having lower than Arab world average percentages of graduates in scientific and technical subjects (more on this in the following section).
Fostering a culture of entrepreneurship among the youth will be key to addressing many of the challenges above, not only through the creation of start-ups but also through increasing the appeal of existing private companies as valid career options for many young Arabs. Recent success stories of companies in the region are likely to have an impact in this regard: the Jordanian online service provider Maktoob was sold to Yahoo! for US$165 million in 2009; Talabat, a Kuwaiti online platform for food delivery, was sold to Rocket Internet for US$170 million in 2015; and Souq.com, an e-commerce website based in the UAE, was sold to Amazon in 2017 (the value of the operation has been estimated at US$650–700 million). A number of initiatives have been launched to support start-ups, including one led by the International Finance Corporation (IFC) and the World Economic Forum, described in Box 2.
Box 2: 100 Arab Start-Ups Shaping the Fourth Industrial Revolution
Khaled Kteily, World Economic Forum
Being an entrepreneur in the Arab world, which has a regionally unique set of challenges and opportunities, is a category in and of itself. The culture in the region does not reward failure in the same way that it might be celebrated in Silicon Valley. Young Arabs are encouraged to become engineers, doctors, or lawyers—skills that are transferrable across borders and countries. Regional investment strategies do not encourage risk, while stability is a celebrated virtue in countries that have been wracked with geopolitical conflict. And when many countries have been reliant on oil for revenues, the safety nets that support their citizens also disincentivize risk-taking.
Despite all this, in the context of challenging geopolitics, Arab start-ups have found ways to grow and succeed. Dig deeper and you realize that many successful start-ups are providing local solutions to local problems: Syrian-based Mujeeb is a chatbot that understands Arabic. Dubai-based BitOasis provides access to cryptocurrencies for residents in the Arab world. Cairo-based Nafham provides online educational courses in Arabic. Indeed, the future lies here: regional solutions to regional challenges.
Certainly, as governments and businesses alike recognize the critical role entrepreneurs play in addressing revenue diversification, youth unemployment, and more, they will be more willing to create the space for entrepreneurs to flourish. For this reason, the World Economic Forum partnered with the International Finance Corporation to identify, support, and enable the best and brightest entrepreneurs of the Arab world to improve the state of their region through the 100 Arab Start-Ups Shaping the Fourth Industrial Revolution initiative.
During the World Economic Forum’s meeting on the Middle East and North Africa in Jordan in May 2017, start-ups from each country met with their respective top government representatives: the Jordanian start-ups met with the King of Jordan, Egyptian start-ups with Egypt’s Minister of International Investment and Cooperation, and so on. Ultimately, closer collaboration between these parties will help create the ecosystem necessary for entrepreneurship to thrive and generate a regional answer to what Arab entrepreneurship will be.
The success of this initiative has highlighted once more the critical need to continue supporting entrepreneurs and start-ups across the region and, indeed, across the world. The partnership between the World Economic Forum and the International Finance Corporation was extended to include Latin America and is now being considered for other regions in the world that are seeking to better promote innovation and entrepreneurship.
Mastering the Fourth Industrial Revolution and improving the innovation ecosystem
Diversifying the economy, developing the private sector, and creating opportunities for the youth will require increasing the innovation content of the non-oil sector and navigating through the Fourth Industrial Revolution. Creating a thriving innovation ecosystem is not a trivial task. While some Arab countries have already put in place long-term strategies and heavy investments, the entire region still has to fill the gap with the rest of the world when it comes to adopting and developing the most advanced technologies and the industries of the future.
Availability of appropriate talent remains an issue. Enrollment in tertiary education still lags behind and places the Arab world among the worst regions in the world in this regard, after Sub-Saharan Africa and South Asia. Oman, Jordan, Saudi Arabia, and Bahrain all have enrollment rates above 40 percent, but the composition of students by field of education varies significantly among these countries, with the latter two having the lowest share of prospective graduates in technical and scientific subjects (Figure 16). At the other end of the spectrum, Oman and Tunisia have the highest, both above 40 percent. In a world that is changing fast and where it is hard to predict what jobs will be available and skills necessary in the future, having a diverse pool of graduates who are creative and think outside the box is becoming increasingly important. Within the Arab world, Morocco, Tunisia, and Egypt have the highest diversity of skills while Bahrain and the UAE, with a preponderance of students in business administration and law, have the least diversity.
Over the past 20 years, many Arab countries have also experienced a significant decrease in the enrollment rates of vocational education programs. A number of factors have contributed to this drop, including the social stigma associated with this form of education. More efforts need to be made to ensure that the private sector is involved in both designing and delivering vocational training programs. At the same time, authorities must start actively promoting vocational training, positioning it as a valuable alternative to the university track.
Investments for innovation will also require significant and more advanced sources of finance. As outlined in the previous sections, the financial sector has been among the hardest hit by the instability caused by changes in oil prices, but it is now recovering. Yet all Arab countries remain highly dependent on banks, with all other forms of financing (mutual funds, the insurance and equity markets, and the leasing industry) largely underdeveloped. Although the inflow of deposits to banks is generally solid, loans are highly concentrated and given to only a few actors. Furthermore, the financial sector has usually failed to provide sufficient resources to SMEs, contributing to a stagnating private-sector landscape and high average firm age. Regulations on bankruptcy and collateral do not grant sufficient legal protection to borrowers and lenders: countries in the Middle East and North Africa are on average the worst performers in terms of strength of legal rights for getting credit, according to the World Bank’s Doing Business indicators.
With weak capital markets, start-ups have also historically suffered from a lack of financing. However, funding for start-ups is growing, especially in the GCC economies. Equity investment in new technology firms jumped from US$100 million in 2014 to US$1.7 billion in 2016 in the UAE.16CB Insights 2017.
More and more, innovation passes through information technology connectivity and digitalization. Many Arab countries have achieved tremendous improvement in this area in recent years. For example, in just five years the share of people using the Internet in Algeria has more than tripled, to over 50 percent. Yet more than half of the Arab population is still not connected to the Internet, and especially the poorer and more rural areas still lag behind. Expanding the pool of users with homogenous preferences and cultural backgrounds will allow the generation of a critical mass and the network effects necessary for the success of many of the technologies and business models at the core of the Fourth Industrial Revolution.
Trend Impact Coefficientct = connectiontr = concerncr
where connectiontr is the share of experts in the Global Risk Perception Survey that have identified a causal link between trend t and risk r, and concerncr is the percentage of times risk r was selected by businesses in country c among those of highest concern over the next decade, based on the Executive Opinion Survey.
Results should be interpreted keeping in mind that, once the causal link between trends and risks is established through the assessment of the respondents to the Global Risk Perception Survey, the connection between trends and countries is exclusively based on how worrisome those risks are in the perception of companies. These perceptions can be driven by a number of factors that go beyond the effective threat represented by those risks and the level of preparedness of the country. This approach also assumes that global trends are occurring with the same intensity in all countries. As in the case of an aging population, this assumption is unlikely to be equally valid for all trends.