USCFL - Why the Middle East doesn't work

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Article:	Why the Middle East doesn't work
Author:	Nigel Holloway and Kerry Dolan
Date:	March 2002

(As appeared in Forbes Magazine)

Osama bin Laden required a dry tinderbox to ignite a world conflagration. The surest method to dampen things is to find better jobs for would-be terrorists.

A good way to find out what's wrong with the economies of the Middle East is to go to Jersey City, New Jersey, across the Hudson River from the World Trade Center. There you'll find plenty of Middle Easterners who planted their entrepreneurial seeds in turf a lot more fertile than that found back home.

One such is Magued (Mike) Nour, president of AmericaTrans Overseas Shipping on Summit Avenue. A forthright Egyptian with the confidence of a sea captain, he declares that economies in the Middle East are only as good as the cost of doing business there. Those company costs are much higher than in the U.S., he says, waving his Turkish cigarette above the shipping manifests in Arabic in his office.

"All it takes is $150 here to make a corporation, a couple of thousand to rent office space and a couple of thousand for bond. In Egypt, it costs half a million Egyptian pounds, $150,000, for a license to begin the same business," he says. Forget about renting an office. Fifty-year-old rent controls have dried up the market. "Nobody wants to rent an office to someone for $200 a year," Nour says. "So if you want to start a business, you have to buy a building." Or an apartment.

There's more, of course. An exporter's letter of credit requires a 100% deposit in Egypt. In the U.S. it is 10%. You want a telephone line quickly? That will cost you $700 in bribes. Taxes? A nightmare, says Nour. "If you make $1 million a year in your business, the government will say that you made $5 million. The burden is on you to prove you didn't."

The catalog of woes is much longer, but you get the picture: lots of red tape and corruption; plenty of dormant capital and not enough access to it. And this is Egypt, which has one of the more reform-minded governments in the region. Syrian business has hardly changed in 30 years: some additional fat cats and the rest state-owned enterprises.

Of course, entrepreneurs face similar obstacles in other parts of the world. But the problem is more urgent in the Middle East. Because of a baby boom in the 1970s and 1980s, the region has a demographic bulge, (See Chart below), with lots of young and educated people entering the labor market--but finding no work. The region's labor force is growing by 3% to 4% a year, the fastest rate of increase in the world. Living standards have stagnated for the past 20 years, causing incomes in the region to fall further behind East Asia and the West.

This is the tinderbox that Osama bin Laden ignited. The "officers" in his terrorist militia are educated Muslims, not lumpen proletariat. Mohammed Atta, the Egyptian reputed to have led the hijacking operation on Sept. 11, was sent by his father to Germany to gain an advanced degree in engineering to get a better job.

"When governments in the Middle East talk about nation-building, they should be talking about market-building. Markets are the main tool of economic empowerment for the disenfranchised whose numbers are growing at an extremely rapid rate," says Glenn Yago of the Milken Institute, a think-tank near Los Angeles that has paid particular attention to the Middle East.

In the past the region's governments would have "solved" the problem by employing the new entrants themselves. But they can no longer afford to do so. They can try to blame it on declines in the price of oil, but if they had adopted better policies this would not pose a problem. The fact is that their economies don't work, and the best way to fix them is to create a framework in which entrepreneurs can build businesses that will employ the millions who don't have jobs.

It was not always this way. In the 16th century, when it was at its strongest, the Ottoman empire came within spitting distance of Vienna, its power fueled by superior technology and a strong merchant class. Islam had a lot going for it, economically. The prophet Mohammed was himself a trader, plying between Jerusalem and Mecca. Collecting interest is forbidden by the Koran, but "the idea of being an entrepreneur and taking money and turning it around for profit is deeply rooted in the religion," says Ahmed Zayat, the CEO of Al Ahram Beverages in Cairo.

The region stands athwart three continents, Europe, Asia and Africa. Its ideal location gave rise to trade but also made it difficult and expensive to defend against interlopers. The Ottomans succumbed to European domination in the 19th century, but the region emerged after World War II with socialist policies that deeply scarred its economies. Some, such as Syria, Iran and Iraq, are still suffering from heavy state ownership and highly distorted prices. Iran spends more than 12% of GDP subsidizing the cost of energy. Throughout the Middle East, the public sector's share of the economy is among the highest in the world, at 32% of GDP, compared with 20% of GDP for other low- and middle-income countries.

Except for Israel, the Middle East has never emphasized the export of manufactures, a strategy that worked so well in East Asia. Indeed, Egypt has seen manufactured exports fall, from 8% of GDP six years ago to less than half that today. This has left the region dependent on erratically priced oil, which makes up 73% of the region's exports. "The Middle East has not really embraced globalization," says Omar Salah, the CEO of Century Investment, Jordan's largest private-sector employer. "The problem is that we don't really trade with each other." Indeed, even Africa does more of such commerce.

Israel, of course, has had little choice but to find markets outside the Middle East. This has proved a blessing in disguise, because it has cushioned the economy against the turmoil within the region. Just as important, Israel's capital markets mesh closely with those of the rest of the world, Nasdaq in particular.

Capital markets elsewhere in the region are virtually nonexistent. "The Middle East has neither the breadth nor depth of financial markets to support development," says Yago. Beginning in the 1970s, oil windfalls were put into international banks, where they fostered activity nearly every place else. The combined capitalization of the region's equity markets, including Israel's, is only 0.65% of the world's. The shares that are traded are highly illiquid, and almost no venture capital is available.

"The young entrepreneur worries about getting finance, and the financier worries about the enforceability of contracts," says Mustapha Nabli, the chief economist for the Middle East at the World Bank.

The banking system isn't much better. There's an almost total absence of competition among the banks, thus little incentive to lend to small businesses. "To get a loan at all from a bank, you almost always have to pay a bribe," says Maher Ammar, a mechanical engineer in Egypt who lost two jobs in as many years as a result of cutbacks. In Syria the government recently announced that it would allow private banks to operate; all the banks are owned by the state. Syria's president, Bashar Assad, has proven to be a big disappointment as an economic reformer since succeeding his father in 2000.

Not so his counterpart, King Abdullah of Jordan, who assumed the throne 18 months earlier. He has privatized most of the country's state-owned industries, implemented a free-trade pact with the U.S. and revamped the school system. Economic growth was a resilient 4% in 2000 and was running at the same rate in the first nine months of 2001. "Some other countries do not have the enlightened, bold leadership to take them in this direction," says Henry Azzam, the CEO of Jordinvest, a regional bank based in Jordan. Dubai is another bright spot.

In Egypt reforms that began in the late 1990s have been put on hold. "It's politics. If you privatize, you have to lay off people," Azzam says.

And of course conflict is a continuing scourge. Israel has managed, fitfully, to prosper in spite of war. For other economies, true peace may be a sine qua non.

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