Things must change

The Arab world’s economy stands at a crossroads. Here are some ideas on how to boost investor confidence and kickstart business activity

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By  Massoud Derhally Published  July 3, 2003

|~||~||~|In May, President George W. Bush proposed a plan to establish a free trade area in the Middle East. The premise behind such a strategy is that free trade and enterprise would have a trickle down effect, bringing about democracy, pluralism, economic transparency and helping fight what America considers homegrown terrorism in some parts of the Arab world. However, regardless of what one may think of the American proposal, in order to achieve its projected goals, Arab and Gulf states have no choice but to liberalise and diversify their economies.

The Middle East region has been unable to unlock its potential as a result of several factors. The intractable Israeli-Palestinian conflict, now in its fifty-fifth year, has consistently detracted from whatever gains Arab states could get from their natural resources. Those at the frontline, notably Jordan, Syria and Lebanon, have suffered most.

One way in which the effect of uncertainty manifests itself is the brain drain which all of the aforementioned countries suffer from. With limited or no opportunities at home, and high unemployment rates, many citizens continue to go abroad in search of a better life. Away from the Gulf, Iraq, which saw three wars, and was crippled economically, has, without a doubt, affected the economies of the Gulf, some more than others.

For much of the 1980s, Gulf countries subsidised Iraq’s war with Iran. This drained state coffers of billions of dollars amidst a global recession. The subsequent invasion of Kuwait rattled the region. It brought about a tremendous amount of capital flight, as investors were more interested in security. It slowed economic growth even in the most buoyant of the Gulf economies. In a special report on the region, entitled “The Middle East Outlook Post-Iraq”, Fitch Ratings, an international rating agency, stated that although the end of the war in Iraq has improved regional stability, ongoing geopolitical tensions combined with structural economic weaknesses effectively constrain the economic and credit outlook for the Middle East.

Johnny Abedrabbo a senior economist at Saudi Arabia’s largest bank, NCB, agrees. “On the political front, the ongoing Arab-Israeli conflict as well as the Gulf war trilogy constitutes a major destabilising force for investment flows into the region,” he says. “Consequently, economic development of many Arab states, including Jordan, Syria and Lebanon, as well as Gulf states, remains hostage to these political tensions.”

If the dust settles soon in Iraq, the potential is great not only for Iraqis but for the majority of the Arab states. With recent summits in Sharm El Sheikh and Aqaba, and what appears to be a paradigm shift in America’s Middle East strategy, one can argue that the time is ripe for Arab countries to overhaul their economies.

“The lack of democracy and the absence of public liberties were necessary for the stability of the mostly autocratic regimes in the region. September 11 changed all that,” says Henry Azzam, CEO of Jordaninvest. “The Arab region today is at a crossroads. Our leaders can either choose the traditional conservative approach towards reform, aimed at marginal damage control, or take bold decisions, with a clear goal to secure the future.”

Despite the colourful slogans and some relatively genuine attempts at economic liberalisation in the Middle East, Arab economies continue to be influenced not only by politics but also oil. In March 2002, Arabian Business drew attention to what we describe as the ‘oil curse’ that has held back the cause of economic reform in the majority of the Gulf States.

In the bigger scheme of things, the Arab world needs to integrate economically to become a solid economic block. Arab markets have lured little foreign capital, even though a number of countries have initiated privatisation programmes to awaken their sluggish economies and entice investors. While the geopolitical situation in the region has played a vital role in deterring these funds from pouring in, legal and institutional impediments in many Arab counties continue to stifle economic growth and development.
Of all the regions of the world, the Arab world lags behind Latin America, Southeast Asia, Australasia, Europe and North America. The first Arab World Competitiveness Report (AWCR), launched by the World Economic Forum in September 2002, drew attention to the low level of integration of Arab economies into the global economy. “Growth of real trade ratios in the MENA region-aside from oil related volatility-has been weak,” said the report. “The major Latin American and East Asian economies have made consistent inroads into MENA Markets, while MENA exporters have not significantly penetrated the markets of Latin America and East Asia.”

The Arab world needs to improve its economic performance and take fuller advantage of the opportunities in an increasing global economy. It can do so by “reforming the current bureaucratic, inefficient and corrupt public sector as well as invoking transparent rules and regulations for the operation of the private sector,” says Abedrabbo. But while some countries have accelerated reform on both the political and economic front, others have not followed through. Most of the countries in the Gulf have paid nothing more than lip service to job creation and economic transparency. While some efforts are bearing fruit, there remains much room for improvement.

Although the GCC states are in a better state of health than the Levant or North African states, economic policies still deter foreign capital flows and push local investors to amass their funds abroad. “Given the high population growth rates and the associated investment requirements of the region, Arab countries are in dire need of foreign capital in order to catch up with the globalisation train,” says Abedrabbo. “However, foreign direct investment (FDI) flows to the region have represented less than 1% of the total over the past 10 years, suggesting a serious ailment in attracting these funds.”

In order to reverse this trend and move Arab economies forward, serious efforts should be made in order to drastically lower dependency on oil while at the same time overhauling the current legal and institutional structures and enforce a sense of accountability. Women need to be empowered; labour rights need to be overhauled; corporate governance needs to be strengthened; and last, but not least, rote learning needs to be substituted with critical thinking.

Arabs balk at the thought of being submissive to American policy recommendations and more often than not, they maintain that they and they alone will set the path and timing of democratisation and reform.

As the Lebanese Daily Star wrote in an editorial this year, “Even if the democratisation campaign of the US is genuine, it will not be able to put in place new standards of Arab governance. Democracy and reform should be homegrown, taking into consideration internal conditions and limitations of the various countries.

“It is up to us to decide how we want to transform our countries in order to step firmly into the twenty first century. However if Arab countries do not take the necessary steps to implement the much needed reforms, these will be imposed from the outside, and we would have only ourselves to blame.”

What follows is a package of ideas for improving the business climate. Some of them are practical measures, some require a change in mindset, whilst others may seem radical. However, since they are based on what we’ve been hearing over the years, they are largely your ideas.
1. Listen to business. Consultation and exchange of views between the public and private sectors is vital if economies are to move forward and develop. Whilst representations can be made in private and through ‘unofficial channels’, there’s nothing like open consultation and debate. That’s why recent initiatives like Dubai’s Executive Council and the creation of vertical Business Groups by The Dubai Chamber of Commerce and Industry (DCCI) deserve credit.

The Economic Council is made up of around forty people from Dubai’s largest family business groups and representatives from government and semi-government institutions. Although this experiment is still in its early days, we understand that the issues raised and debated by the Economic Council are taken up at the Executive Council, the 14 member body that meets weekly under the chairmanship of Sheikh Mohammed.

As for the Chamber’s business group initiative, this involves the creation of groups focused on a specific industry and consisting of people from that industry. The aim is to hear the opinions of the hundreds of small and medium businesses in the city.
DCCI representatives are present at group meetings and have pledged to act on the points raised at them. “We’re trying to have clear channels of communication with them [companies] and the most important thing is to have their input and feedback,” deputy director general, Dubai Chamber of Commerce and Industry.

Of course, it’s too early to say whether or not the Executive Council and Business Groups will ultimately make a difference. It would certainly help if what goes on in these meetings was made available to the public. By making their proceedings public, policy makers will be under more pressure to act on positive suggestions.

2. Take a serious approach to nationalisation. “I think that localisation is absolutely vital for the Middle East.” You’ve heard that quote many times, but how often does it feel like lip service and how often does it seem to be for real? To many people, steps towards localisation seem to consist of banning foreigners from certain sectors, such as retail and taxi driving, and forcing quotas on companies. The result usually seems to be that taxi firms go out of business because they can’t get the people they want, or they end up paying fines, where this is an option, for failing to meet quotas.
Let’s look at localisation in a different way. First of all, there’s no quick fix but persuasion rather than forcing quotas could yield some success.

The private sector could, for example, provide induction and training to nationals, with the government helping to meet the bill. Another idea is for the government to subsidise the salary of an entry level national where it exceeds that of an expatriate, with the assumption that the expat salary and local’s salary will reach some kind of parity as they rise through the ranks.

On a less positive note, private sector companies need to be given the same kind of leeway to dismiss nationals as they are to dismiss expatriates. As one Saudi analyst put it, “Saudi companies don’t want to hire Saudis because they think they may have a liability on their hands.” All in all, if the so-called ‘risk’ of hiring nationals was somehow softened by governments, then the private sector might get more involved.

3. Make privatisation work. As somebody in the offices of ITP recently commented, we hear a lot about the word privatisation, but what does it mean? In its broadest sense, it means transferring state companies to private sector ownership, allowing those companies to be run more efficiently. In return, the government receives cash that it can either reinvest or use to pay off public debt.

No problem whatsoever with the theory, but governments need to ensure that privatisation benefits the consumer first and foremost, which means better services at more competitive prices. Governments that look at states assets as cash cows to be milked will get it wrong. Those that look at privatisation as a way to create jobs and improve services with wider benefits to the economy will get it right.
Just compare Bahrain’s recent GSM tender with some of the ideas that Lebanon’s government is proposing for its GSM operators. Bahrain’s government gave its second GSM license away for a song, along with other benefits, and both MTC, which got the license, and Bahrain’s authorities are talking confidently of creating jobs for nationals and improving the overall economic client in the country.

Contrast that with Lebanon, which has come up with some seemingly crazy ideas for how to sell off the country’s mobile operators. One suggestion is to have the government retain 40% of the two GSM operator’s annual revenues, a scheme guaranteed to cut off investment and keep prices high.

Governments, particularly those need to pay down the public debt, are entitled to seek a return on their assets. At the same time, however, they need to go about privatisation in such a way that a public monopoly doesn’t become a private one and consumers get the best deal.
4. Rethink agency laws. This is a tricky one, since exclusive agency rights are, more often that not, guaranteed cash cows for large family groups. Many companies also like to trumpet these rights, especially the idea of ‘exclusivity’, rather proudly and won’t be willing to give them up easily.

It would also be harsh to say that all exclusive agencies are a disaster. Some large family groups do indeed serve the brands they represent well.

However, the rationale that the market is too small to have multiple distributors and retailers can no longer be taken seriously. Every country in the GCC has decided that having one telecomms company is no longer the way forward, so why should only one company be allowed to represent a car maker, for example?

Surely far better to let international brands choose how they want to be represented and how they want to structure the relationship with their local partners. By way of a compromise, measures could be taken to prevent companies buying market share.

In such a scenario, companies will not only be competing on price, but also on service and support. Consumers will choose the agent that provides the best service at a reasonable price, raising the level of the whole market and increasing the overall level of business.
Need we also mention what can happen when people fall out with their agents. Remember a large American car maker that got dragged through the courts for years and a major IT company that wanted out of an exclusive agency for years until it got its way earlier this year. Another good reason for scrapping agencies is the fact that it is holding back participation in the World Trade Organisation and the access to global markets that this would allow.

5. Make companies audit their accounts. Let’s face it, most companies’ balance sheets are a mess. An auditor at one big name consulting firm told Arabian Business over dinner that it’s not uncommon for money owed to a regional company to represent 50% of its annual revenue. Aside from making it more difficult for businesses themselves to keep a grip on their operational costs, banks are being left in the dark over the actual financial health of their clients and governments are finding it harder to collect revenues. Not only does this limit the company’s ability to invest in itself, but the company may also spend against money it is owed in the hope that the cash will eventually turn up, perpetuating the problem of money owed.

It’s not just governments trying to collect taxes or ‘fees’ that could be losing out. Without reliable records of a company’s financial health, credit ratings agencies cannot exist, banks are more reluctant to lend money and companies are less likely to form partnerships and even merge with each other. If companies aren’t keeping accounts, more business failures, higher indebtedness and a less stable business environment overall are the consequences.

The thing here is that forcing companies to audit their accounts isn’t exactly a new idea - like mandatory health insurance, it’s been on the table for some time. It wouldn’t therefore be the shock you might think and it could be phased in gradually, starting with large companies first. The recent companies law for DIC-registered businesses also shows that moves are already afoot in this direction.

6. Control spending. Like many things, this is easier said than done, but you do often get the feeling that governments, particularly in the Gulf, aren’t serious about controlling spending. Budget statements lack any transparency and come the end of the year, spending has nearly always exceeded original estimates, even when oil prices are high. Governments need to get serious about controlling spending and paying off debt, so that they can redirect spending into productive areas. Rather than going into ‘off budget’ items and debt servicing, money should be going into training programmes, and infrastructure improvement.

It’s not as if governments can’t do anything about overspending. Rather than keep on borrowing money year after year, privatisation proceeds could be used to pay down debt. The Saudi government, for example, is reckoned to own 33% of the country’s stock market capitalisation, which would be worth SR90-100 million if it were to be sold off. Other governments are also sitting on top of state assets worth billions.

As well as simply controlling spending, one important way to control budgets is to apply pressure. Budgets simply need to be made public and audited by third parties so that expenditure can be monitored and questioned where necessary.

7. Create commercial courts. It was Mohammed Al Abbar, of Emaar Group and the Dubai Department of Economic Development, who told BBC World’s Hardtalk that investors won’t go into places where they fear there is no legal protection. One possible solution: create specialist commercial courts to hear industrial disputes. These courts would be staffed by graduates and court hearings overseen by experts in the field of business and commerce.

They could pass judgement on any number of commercial issues, such as agency disputes and unpaid bills, to name just two things that blight business in the region.

They could appoint independent observers, possibly from overseas, to oversee proceedings, and legislation could be drawn up with the help of experts from organisations such as the IMF and World Bank. Significant unresolved cases could be appealed to the ICSID, the World Bank affiliate that recently awarded an Egyptian-American investor $100M for the misappropriation of assets by the Egyptian government.

Of course, the courts would have to prove themselves overtime. However, if they were seen to stand up for the rights of investors, whether overseas or local, they could go a huge way in shoring up investor confidence.
8. Create centralised credit bureaus. Yes, you have heard this one before in the pages of Arabian Business and we’ll say it again. You’ve all seen the stories in the newspapers about conmen who borrowed money from lots of different banks and then absconded, but a much bigger problem is the fact that an absence of credit agencies makes it harder for companies to access the cash they need to grow.
Most small or medium sized companies will tell you how hard it is to get a sizeable bank loan unless you are involved in real estate or some other ‘tangible’ activity. OK, there’s not much you can do about the conservative nature of banks. But centralised credit bureaus that provide information on both personal and corporate indebtedness could go a long way in encouraging banks to be more supportive of smaller businesses.

In mature economies, smaller businesses account for the vast majority of commerce and, most importantly, job creation. As the Middle East diversifies and tries to rectify its dependence on oil, that will increasingly have to be the case here.
Since banks aren’t great at co-operating with each other, it will be up to governments to push the idea of centralised credit bureaus and make banks file reports on their clients. But the effort would certainly be worth it, since it’s the small businesses that represent the future of regional economies.

9. Accelerate the process of economic integration. The level of trade between Arab states remains woefully low and there simply isn’t any good reason for it. In fact, the amount of business that goes on between Arab countries currently represents something like 7.5% of all Arab economic activity. Why should a country import manufactured products from the other side of the world, when it can get them just as good from a country next door.

The current state of affairs is to some extent a historical legacy, caused by the Cold War divide when countries had to choose sides. But is as much as down to the bureaucratic mentality that dominates the thinking of Arab governments.

The time to shed that thinking is long overdue. At a time when the world is rearranging itself into economic blocks such as NAFTA, the EU and ASEAN, the Arab World is making only tentative steps towards economic integration.

The GCC Customs Unions is a vital first step towards enhancing economic integration, but more needs to be done. The bureaucratic mindset needs to be shed; governments need to understand that what they currently import from outside the region can be sourced just as easily at home; and the emphasis of government policy needs to shift from protecting indigenous industries to promoting exports and creating value added industries.

We agree that this is all easier said than done, but what is currently so apparent is the complete lack of debate on the subject. Actually talking about the need for more intra-Arab trade would be a good starting point.

10. Reform company boards. Two heads are better than one, or, more specifically, the insight of independent directors would help many companies improve the way they are run. The region’s regulatory authorities might want to consider obliging companies, starting with the largest first, to have a certain proportion of independent directors on their board. These ‘independents’ should not have major shareholdings in the company and should not have any significant business relationships with it. By being outside of the everyday goings-on of the business, they can look at things more objectively and will have more leeway to question or contradict the management of the company.

Borrowing another idea from Western business magazines, regulatory authorities might also look at the idea of separating the positions of chairman and CEO/managing director. When a CEO is also the chairman of the board, he is effectively reporting to himself, chairing meetings that are being held to review his own performance as CEO.

In the UK and Europe, it is standard behaviour to separate the posts of chairman and CEO. Why not do the same here?
Why should governments dictate the way businesses are run, you may ask? Because directors should serve the interests of shareholders, stakeholders (such as creditor banks) and last, but not least, their customers

Those are some of our ideas. You might agree with some or all of them; there are others we could have included; and we’re sure that you, our readers, will have your own suggestions. We know that you can’t wave a magic wand and everything will be OK, but we do believe that the ten ideas outlined above could go a long way towards improving the economic climate in the Middle East.||**||

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