A more even-handed approach to economic reforms

As many Arab countries going through uncertain political transitions begin to redefine the social contract with their citizens, the fundamental challenge they will face will be the question of economic reform and how to go about it.

Unfortunately, given the very narrow political space the newly-elected and appointed leaders must navigate — in the face of a heap of accumulated distortions resulting from past economic mismanagement and corruption coupled with extremely high-popular expectations — make the policy options before them extremely difficult to navigate. They are also fraught with even more political dangers.

This difficult trap makes the appeal of populist economic policies like increasing public sector employment, wages, and subsidies even more difficult to resist and much more dangerous for the economic future.

In my view, the new leadership in transition countries must avoid two important policy options at all costs, despite all political temptations. The first is the popular pressure to extend or expand policies that will increase the direct involvement of the state in economic life, like enlarging public sector employment, higher wages, more generous subsidies, exchange rate manipulation, etc.

The second, is the misguided political urge to “throw the baby with the bath water”, in other words, undoing or reversing good economic policies adapted by former regimes, under the banner of breaking with the past.

Despite the good intentions, and the obvious political pressures and incentives, the fact is such policies will only deepen the economic malaise in these countries and lead to even worse failures at some point in the future, and at much higher political and economic costs. Decades of such policies in our own region, as well as others like Latin America for example, leave no doubt that the costs are devastating in the long run.

Economic history is littered with evidence and warnings on the consequences of such policies. From unleashing inflation, lowering standards of living, higher levels of corruption and creating deeper inequalities to killing the private sector and undermining development are consequences that are clear to anyone familiar with the economic history of many developing countries in our region and beyond. On the other hand, economic history has also a great deal of good advice on what policies have worked, and why.

In my mind, the most important policy priorities for Arab governments at this critical transition period should be:

* Facilitating the establishment and growth of the private sector should be at the top of the policy agenda for transition countries. Development of viable small- and medium-sized enterprises is particularly important, given that most employment creation happens in this sector.

The huge potential of the private sector will require that governments establish a new legal framework for private sector firms that gives them a clear understanding of the regulatory context in which they will be building their new enterprises and gives them the flexibility needed to establish successful start-ups.

One area of regulatory context that is particularly important is that related to labour. Some former regimes maintained rigid control over private sector hiring, firing and wage decisions, even so far as to set wages for each industry and position. In order to stimulate job creation in the private sector, new labour laws must give employers control over determining wages and the ability to dismiss workers on the basis of poor performance or economic necessity.

There is also a role for government — particularly in the early phase of transition — in supporting the emergent private sector with seed funding (either through grants or low interest loans), loan insurance and access to advisory services and business development services. Programmes in each of these areas will help new entrepreneurs to successfully transition from small start-ups and begin building their businesses.

* Secondly, it is a core priority to reduce the size of the civil service, to lower public sector wages and to otherwise lessen the attractiveness of work in the public sector. Given the scale of public sector employment in Arab countries and the dependence of so many families on income from these, this advice is not put forward lightly.

Public sector rationalisation will require careful study of the costs to potential winners and losers in the reform and the development of mechanisms designed to ensure that downsized workers dependent on public sector income are protected as much as possible.

* Thirdly, our region heavily subsidises electricity, fuel, health services, education, and basic food items. While such subsidies provide an important resource for many families, they do the economy a fundamental disservice.

They introduce market inefficiencies and distortions that often lead to black market profiteering and corruption. They also crowd out opportunities needed to help build the private sector. Moreover, because the subsidies are not targeted — but are available to the whole population — they lead to waste, subsidising the rich, and lowering the benefits to the poor and disadvantaged who need them most.

Ideally, governments would move to abandon subsidies in favour of targeted cash payments to low-income households on the basis of identified needs. If there is no ability to legitimately identify households based on income, the government might at least target households by making them enrol in the transfer programme using geographical information or by linking transfers to participation in work or education programmes designed to assist those in need.

The above-described issues are but a brief overview of the policy decisions that governments in our region, especially those in transition, are tasked with in defining the economic future of their countries. As such, they reflect elements of a comprehensive strategy for reform, as well as politically difficult decisions that need to be made on the part of the new leaders.

The ability to move forward on all or even some of these issues will depend on each government’s ability to effectively communicate the need for these reforms and to explain them clearly and credibly to the people. In return, the future economic prosperity and development of our region will depend on it.

— The writer is advisor to the Executive Director, The World Bank Group.