83725 November 2013 – Number 110 MENA ECONOMIC AND DEVELOPMENT PROSPECTS 2013: INVESTING IN TURBULENT TIMES Elena Ianchovichina, Shantayanan Devarajan, and Martijn Burger1 Introduction: The political and social upheavals that followed the Arab Spring of 2011 continue to dominate economic activity and near term prospects in the Middle East and North Africa (MENA). Although political transitions bring promises of greater political and economic freedom, in MENA the process remains far from complete and has been accompanied by increased political and macroeconomic instability in 2013. In Egypt, rising social and political tensions weighed heavily on confidence. In Syria, a marked escalation of the civil war exacted a heavy economic and human toll, with spillovers to neighboring Lebanon, Jordan, and Iraq. Oil production in developing MENA oil exporters has fallen because of security setbacks, infrastructure problems, strikes, and in the case of Iran, economic sanctions. Meanwhile, the GCC oil exporters continue to make up the loss in oil production, while providing financial support to the region’s transition economies. The 2013 Regional Outlook: The outlook for 2013—and more so for 2014--is uncertain and to remain weak or weaken relative to 2012 subject to a variety of risks, mostly domestic in across MENA and average 2.8%, down from the nature and linked to political instability, while estimated 5.6% in 2012. Growth has been most global economic conditions have become more volatile in the MENA’s developing oil exporting favorable. In 2013, economic growth is expected countries, and is projected to slow down considerably due to unfavorable developments, especially in Libya, Iran, and Syria. Growth of 1 This Quick Note is based on the Executive Summary of the MENA’s oil importing countries is expected to October 2013 MENA Economic Development and Prospects (EDP) report. This MNA K&L Quick Note was cleared by remain weak and below potential, but Shantayanan Devarajan, Chief Economist of the MENA Region, performance will strengthen slightly relative to the World Bank. Elena Ianchovichina is Lead Economist in the 2012 (see Figure 1). The economic expansion of Office of the Chief Economist of the MENA Region, the World Bank. Martijn Burger is Assistant Professor at Erasmus University, the GCC economies will slow down relative to Rotterdam, the Netherlands. 2012, but their pace will still be strongest in the A more disaggregate picture of FDI in MENA region. Assuming the political situation evolves shows some differences from the rest of the toward greater stability and clarity, economic world and over time. Although the region growth is expected to pick up and average 4% in attracted more FDI in the 2000s relative to the 2014. 1990s, reflecting improvements in the business environment in many economies, the majority of Oil importing countries will continue to face countries performed below potential. In external financing difficulties and fiscal addition, FDI was concentrated in the resource- pressures, but macroeconomic vulnerabilities intensive and services sectors, while nonoil have also been growing in developing oil manufacturing FDI remained weak. Developing exporting countries. The absence of significant oil importing countries received just 30 percent economic reforms, combined with persistent of the region’s FDI inflows and a large amount political and macroeconomic instability, is likely of it came from the GCC economies. As oil to keep investment and growth below potential prices rose in the 2000s, source countries shifted in developing MENA not only in the short run, investments toward the oil exporting countries but in coming years, unless there is a break with in the region. After 2010, FDI inflows declined past practices. across the region, public investment declined in developing MENA, while domestic private Figure 1 - Post Arab Spring Regional Growth investment remained relatively unaffected. Record and Outlook (annual % change) 10 Figure 2 - Net FDI Inflows to MENA and Other Developing Countries (% of GDP) 8 6 6 5 4 4 2 0 3 2010 2011 2012e 2013p 2014p -2 2 -4 1 MENA GCC oil exporters Developing oil exporters Oil importers 0 1991-1995 1996-2000 2001-2005 2006-2010 2011-2012 Rest of the Developing World Source: World Bank. Middle East & North Africa: GCC Middle East & North Africa: Developing Economies Foreign Investment in MENA: The Arab Source: UNCTAD data. Note: GCC= Gulf Spring, coming on the heels of the region’s Cooperation Council recovery from the global financial and economic crisis in the late 2000s, had a dampening effect Whether the post-2011 decline in FDI has been on foreign investment in the region (See Figure due to political instability is not clear-cut, just as 2). Prior to the Arab Spring, aggregate it is not in the literature. Some aspects of investment and foreign direct investment (FDI) instability, including the quality and stability of flows to MENA followed the rest of the world. government institutions and policies, did play a Starting from a low base, FDI flows to the region role, but others, such as democratic increased in the early 2000s, peaked in the accountability, did not. Furthermore, FDI flows second half of the period, and declined at the to the resource-intensive and nontradable end of the decade. Whereas the rest of the sectors appear immune to political instability, world’s FDI picked up after 2010, FDI flows to but FDI flows to the tradable sectors exhibit a MENA continued their decline as economic and clear negative response. Overall, the rise in political conditions worsened. political instability associated with the Arab Spring events (Figure 3) has had a significant, November 2013 · Number 109 · 2 negative effect on FDI flows to the region At the same time, it has discouraged the high (Figure 4). Finally, economic conditions have quality FDI in non-resource tradable continued to play an important role in attracting manufacturing and services needed for export FDI. upgrading and diversification. By hurting these efficiency-seeking investments, shocks to Figure 3 - Political Instability Index, 2000-2012 political stability exacerbate the clustering of 60 FDI in the extractive industries and non-tradable Very High Risk sectors – a problem associated with policy 50 MENA distortions and political capture that predate the High Risk GCC Arab Spring. 40 Moderate Risk Policy Challenges and Priorities in MENA: The Developing Oil Importers 30 Low Risk Developing Oil findings of the EDP outline several policy Exporters challenges and priorities. The report argues that MENA countries may find themselves in a Other Middle 20 Income Very Low Risk Countries High Income resource trap unless they strengthen institutions OECD 10 and improve the investment climate, especially political and macroeconomic stability. 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Protecting the property rights, and committing to stable and transparent policies will encourage Source: ICRG database. *Note: An increase in the investment, especially foreign investment in the index reflects an increase in political instability. MENA=Middle East and North Africa; GCC = Gulf labor-intensive nonoil manufacturing and Cooperation Council; OECD=Organization for service sectors of MENA, and thus job creation, Economic Co-operation and Development. growth, and structural transformation. Achieving consensus on political reforms is a Figure 4 – Effect of Political Risk on FDI in necessary pre-requisite for sustainable, high MENA, 2003-12 growth in developing MENA. But so are structural reforms that address long-standing challenges, including distortionary and unevenly enforced regulations, favoring of privileged businesses, macroeconomic imbalances and expensive subsidies, inadequate and irregular provision of electricity and other infrastructure services, problems with education quality and skills, and poorly functioning markets for labor, goods, and finance. These structural issues constrain growth, with grim consequences for the structural unemployment problem, especially among youth and women. Contact MNA K&L: Source: Based on Burger, Ianchovichina, and Gerard A. Byam, Director, Strategy and Rijkers (2013) “Risky Business: Political Operations. MENA Region, The World Bank Preeti S. Ahuja, Manager, MNADE Instability and Greenfield FDI in the Arab Regional Quick Notes Team: World.” Omer Karasapan and Roby Fields Tel #: (202) 473 8177 More broadly, political turbulence since the The MNA Quick Notes are intended to early 2000s has affected not only the level of FDI summarize lessons learned from MNA and other in MENA, but also its composition; it has Bank Knowledge and Learning activities. The skewed it towards activities that create the least Notes do not necessarily reflect the views of the jobs or that create jobs in non-tradable sectors. World Bank, its board or its member countries. November 2013 · Number 109 · 3