Reviving Arab Reform: Development Challenges and Opportunities 9781839823190, 9781839823183, 9781839823206

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Reviving Arab Reform

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Reviving Arab Reform: Development Challenges and Opportunities

BY

ISLAM ABDELBARY Arab Academy for Science and Technology

United Kingdom – North America – Japan – India – Malaysia – China

Emerald Publishing Limited Howard House, Wagon Lane, Bingley BD16 1WA, UK First edition 2021 Copyright © 2021 Emerald Publishing Limited Reprints and permissions service Contact: [email protected] No part of this book may be reproduced, stored in a retrieval system, transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without either the prior written permission of the publisher or a licence permitting restricted copying issued in the UK by The Copyright Licensing Agency and in the USA by The Copyright Clearance Center. Any opinions expressed in the chapters are those of the authors. Whilst Emerald makes every effort to ensure the quality and accuracy of its content, Emerald makes no representation implied or otherwise, as to the chapters’ suitability and application and disclaims any warranties, express or implied, to their use. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN: 978-1-83982-319-0 (Print) ISBN: 978-1-83982-318-3 (Online) ISBN: 978-1-83982-320-6 (Epub)

Contents

List of Figures

vii

List of Tables

ix

List of Abbreviations

xi

About the Author

xiii

Prefacexv

Foreword, Jeffrey B. Nugentxvii Foreword, Mahmoud Mohieldinxix Acknowledgementsxxi

Chapter 1  Introduction

1

Chapter 2  The Theoretical Basis

5

Chapter 3  Methodology

15

Chapter 4  Insight of Arab Economics: A Reforming Outlook

39

Chapter 5  Economic Stabilisation and Arab Reform

53

Chapter 6  Business and Structural Reform

71

Chapter 7  Social Aspects of Arab Reform

81

Chapter 8  Institutions and Political Aspects of Arab Reform

99

vi   Contents

Chapter 9 

Winners and Losers of Arab Reforms

115

Chapter 10  The Impact of Reform Programmes on Economic Growth: An Econometric Analysis

127

Chapter 11  Towards an Inclusive Development Framework for Arab Reform

169

Concluding Remarks

179

References181 Index191

List of Figures

Fig. 4.1. Arab Potential and Actual GDP with Output Gap (1995–2018). 41 Fig. 4.2. Arab GDP Per Capita Growth Compared to Other Developing Regions. 41 Fig. 4.3. GDP Per Capita Growth for Sub-Arab Groups. 43 Fig. 4.4 Arab’s Chronic Low-growth Syndrome. 45 Fig. 4.5. Actual and Expected GDP of the Arab Region. 45 Fig. 4.6. Sources of GDP Growth in the Arab Region (1995–2018). 46 Fig. 5.1. Macroeconomic Stability Indicator. 55 Fig. 5.2. Consumer Price Index – Inflation Rate (Average). 56 Fig. 5.3. Recorded Unemployment Rates (%). 58 Fig. 5.4. Exchange Rate LCU: US$ (Average). 59 Fig. 5.5. The Structure of Public Revenues in the Arab Countries (1995–2018).60 Fig. 5.6. Percentage of Oil and Tax Revenues of Arab Countries from Total Revenues. 60 Fig. 5.7. Budget Balance of Arab Countries as a Percentage of GDP. 61 Fig. 5.8. Budget Balance (% of GDP). 62 Fig. 5.9. Public Debt (% of GDP). 63 Fig. 5.10. External Stability Indicator. 64 Fig. 5.11. Total Arab Exports by Subregions During 1995–2018. 65 Fig. 5.12. Total Arab Imports by Subregions During 1995–2018 (Billion $). 65 Fig. 5.13. Current Account Balance/GDP. 66 Fig. 5.14. External Debt-to-Exports of Goods and Services. 68 Fig. 5.15. Total Reserves in Months of Imports. 69 Fig. 6.1. Aggregate Structural Reform Indicator. 73 Fig. 6.2. Inward Foreign Direct Investment (% of GDP). 74 Fig. 6.3. Domestic Credit to the Private Sector by Banks Growth (% of GDP). 75 Fig. 6.4. The Arab Stock Markets Combined Index. 77 Fig. 6.5.1. Export Diversification Index. 78 Fig. 6.5.2. Export Concentration Index. 78 Fig. 6.5.3. Commodity Structure of the Arab Exports. 79 Fig. 6.5.4. Changes in the Composition of GDP, 1980–2012. 80 Fig. 7.1. People Living on Less than the International Poverty Line. 82

viii    List of Figures Fig. 7.2. Poverty Headcount Ratio at $3.20 a Day (2011 PPP) (% of the Population). Fig. 7.3. Arab Headcount Poverty across Household Characteristics. Fig. 7.4. Top 10% Income Shares across the World. Fig. 7.5. Top 1% and Bottom 50% Income Shares Across the World. Fig. 7.6. Human Capital Indicator (H). Fig. 7.7. Infant Mortality Rate (Per 1,000 Live Births). Fig. 7.8. Life Expectancy at Birth, Total (Years). Fig. 7.9. Health Expenditure, Public (% of GDP). Fig. 7.10. School Enrolment, Primary (% Gross). Fig. 7.11. Scientific and Technical Journal Articles. Fig. 7.12. Physical Infrastructure Indicator. Fig. 7.13. The Relation Between Physical Infrastructure Indicator and the GDP Per Capita from 1995 to 2018. Fig. 7.14. Improved Water Source (% of the Population with Access). Fig. 7.15. Improved Sanitation (% of the Population with Access). Fig. 7.16. Access to Electricity (% of the Population with Access). Fig. 7.17. Fixed Telephone Subscriptions (Per 100 People). Fig. 8.1. Governance Indicator. Fig. 8.2. Voice and Accountability (VA) Indicator. Fig. 8.3. Political Stability and Absence of Violence/Terrorism (PV). Fig. 8.4. Government Effectiveness (GE) (1995–2018). Fig. 8.5. The Relationship Between Government Effectiveness and Public Services Provision (1995–2018). Fig. 8.6. Regulatory Quality (RQ). Fig. 8.7. Rule of Law (RL). Fig. 8.8. Control of Corruption (CC). Fig. 9.1. Relationship Between Structural Reform and Macroeconomic Stability in Arab Countries From 1995 to 2018. Fig. 9.2. Relationship Between Concentration Index and Natural Resource Abundance on Average (1995–2018). Fig. 9.3. Relationship Between Natural Resource Abundance and Governance (1995–2018). Fig. 9.4. The Relationship Between Internal and External Stabilisation. Fig. 9.5. The Relationship Between Unemployment and Inflation During 1995–2018. Fig. 9.6. The Relationship Between Governance Scores and Other Aggregate Developmental Indicators (1995–2018). Fig. 9.7. The Reform Indicators Among ACs Highlighting Violent Conflict (1995–2018). Fig. 11.1. The General Framework for Arab Reform.

83 84 85 85 87 89 90 90 91 92 94 95 95 96 96 97 100 103 104 106 106 109 110 112 117 119 120 121 122 123 124 171

List of Tables

Table 10.1.1. Estimated Models of Reform and its Components on Economic Growth for Advanced Economies. 130 Table 10.2.1. Estimated Models of Reform with Including Governance Components on Economic Growth for Advanced Economies.135 Table 10.1.2. Estimated Models of Reform and its Components on Economic Growth for Developing Countries. 138 Table 10.2.2. Estimated Models of Reform with Including Governance Components on Economic Growth for Developing Countries Sample.143 Table 10.1.3. Estimated Models of Reform and its Components on Economic Growth for Arab Countries. 147 Table 10.2.3. Estimated Models of Reform with Including Governance Components on Economic Growth for whole Arab States Sample.151

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List of Abbreviations

ACs ALO BOP CA CPI CPI CSA DPD DER DW EAS EC ECS EFA EIU EU FAO FDI FE FH GCC GDP GMM GNI GNP HIPIC ICRG ICT ILO IMF IPS IV LCN LDCs LICs LM LSDV M&E

Arab Countries Arab Labour Organisation Balance of Payments The Current Account Consumer Price Index Corruption Perceptions Index Central & South Asian countries Dynamic Panel Data Distribution of Economic Power Durbin-Watson East Asian Countries European Commission European countries Education for All Economist Intelligence Unit European Union Food and Agriculture Organisation Foreign Direct Investment Fixed Effect Freedom House Gulf Cooperation Council Gross Domestic Product Generalised Method of moments Gross National Income Gross National Product Heavily Indebted Poor Ccountries International Country Risk Guide Information and Communication Technology International Labour Organization International Monetary Fund Im-Pesaran-Shin Instrumental Variables Latin America countries Least developed countries Low-Income Countries Lagrange Multiplier Least Squares Dummy Variables Monitoring and Evaluation

xii    List of Abbreviations MDG NAC NGOs NIE OECD OLS OPEC POLS PP PPP R&D RE RPLA RRLA RRLI SSF SUR SWFs TFP UAE UNCTAD UNDP UNESCO WDI WGI WHO

Millennium Development Goal North American Countries Non-Governmental Organisations New Institutional Economics Theory Organisation for Economic Co-operation and Development Ordinary Least Square Organisation of Petroleum Exporting Countries Pooled OLS Phillips-Perron Purchasing Power Parity Research and Development Random Effect Resource-Poor, Labour-Abundant Resource-Rich, Labour-Abundant Resource-Rich, Labour-Importing Sub-Saharan Africa Countries Seemingly Unrelated Regression Sovereign Wealth Funds Total Factor Productivity United Arab Emirates United Nations Conference on Trade and Development United Nations Development Programme United Nations Educational, Scientific and Cultural Organisation World Development Indicators Worldwide Governance Indicators World Health Organization

About the Author

Islam Abdelbary is an Egyptian economist and an assistant professor of Economics at the Arab Academy for Science and Technology. Currently, he is an economic consultant at the United Nations and Alumni research fellow at the University of Plymouth. Abdelbary’s research focuses on Institutional Economics, Sustainability and economic development. He has published several research papers on development reform policy in developing countries and particularly in the MENA region. His research has awarded several international prizes, such as the Ibn Khaldun Prize 2019. Abdelbary also works as an independent researcher in several multi-disciplinary research projects for national and international organisations.

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Preface

The Arab region has numerous natural resources and great human capital wealth, perhaps the largest in the world. A long history of civilisation, supported by a geographical location that mediates the whole world, granted it the largest business centre. Nevertheless, the countries of the region suffer from chronic low-economic growth rates, weak production structures and a decrease in the competitiveness of their products, along with poverty, inequality and corruption rates that are the highest in the world. Despite the success of the development experiences of some countries during the past five decades, they were not sustainable or inclusively planned. As a result of this situation, many uprisings have taken place in most Arab countries, supported by the middle class, especially youth, asking for a change in the status quo and broad reform that includes the economic, social and political aspects of society. For the same reason, I have embarked on this study as my doctoral research project for over 4 years to contribute to the ongoing debate on ways to revive Arab reform from a holistic approach. The study proposed development frameworks (based on some key economic, political and social variables, taking into consideration the distinctive features of each region group) that may lead to more comprehensive and integrated development in the region. These frameworks are a vital strategy for enhancing the effectiveness of reform programmes in the region and achieving targeted inclusive growth outcomes. During these years, five working papers from the thesis have been presented in several international conferences; three of them published as book chapters in the book entitled Impacts of political instability on economics in the MENA region. The outcomes also have awarded several international prizes, such as the Ibn Khaldun Prize, during the ASSA meeting in Atlanta, 2019. In many conferences and meetings, I have received frequent suggestions from experts and discussants to turn the study into a monograph book in order to disseminate the results of the study on a larger scale to target not only academic researchers but also policy-makers, especially in the Arab region. I became eager about the idea to deliver my message to all stakeholders. Thanks to Emerald, this transformation has become possible. Finally, I hope this book represents a good contribution to sustainable development research in the Arab world and inspires the leaders and decision-makers in the region towards achieving the expectations and aspirations of their people.

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Foreword Jeffrey B. Nugent*

This is a rare and much-needed book on the challenges of development, but with special reference to the Arab countries of the Middle East. Despite the remarkable success of a number of these countries historically and, thanks to the oil resources of some of them even in recent decades, Professor Abdelbary correctly detects a general lack of sustainable economic development in the region. Along with that, he finds decreasing competitiveness and weak institutions throughout the Arab region at the present time. He is quite convincing in demonstrating that major economic reforms are needed and that these reforms need to be appropriately designed so as to be more inclusive, carefully coordinated and administered, and complemented by vastly improved institutions including good governance. Rather than either a historical account or a descriptive one as is typical of other books on the region, his analysis is founded on a comprehensive analysis of Development Theory, including not only classical and neoclassical development theory but also the New Institutional Economics and distributional considerations. Unlike textbooks on the Arab region or more generally on Development Economics, it focuses on how the economies of the region have responded to shocks like the global financial crisis and the Arab Spring crisis, and features a careful econometric analysis of 17 Arab countries and 61 other countries from all over the world. In his empirical analysis, he goes to great lengths, both (1) to make use of variables deemed especially relevant to the Arab countries and to their problems, such as export concentration, the relative importance of oil rents, and a number of different governance indexes, and (2) to utilize estimation techniques designed to overcome the usual problems of (a) the relatively short time series of some of the key variables relevant to the analysis, and (b) potential endogeneity of many of the explanatory variables. His straight-forward growth comparisons across regions early in the book shows clearly that Arab countries have fallen far behind the growth of all other regions, especially since 2009, i.e., a period including both the financial and Arab

*

Nugent is Professor of Economics at the University of Southern California since 1976. He is also a senior researcher in this field he has worked on a wide variety of issues, problems and analytical techniques and in and on a variety of countries from Latin America, Africa, South and East Asia and especially the Middle East and North Africa. He has written over one hundred articles in refereed journals, numerous chapters in edited volumes and edited or co-edited four books. He serves on the Board of Directors of several economic associations, and editorial boards of several journals.

xviii   Foreword Spring crises. He traces this back to the general failure of Arab economies to maintain internal economic stability, but in this respect pointing to the greater success of some of the Gulf countries in using Sovereign Wealth Funds to smooth out some of these instabilities. The economic instabilities have in some cases contributed to extremely high-income inequality, armed conflict, violence, civil war and refugee problems. While Abdelbary points to a number of areas in which a number of countries have made significant policy reforms, such as in moving away from the rigidities of central planning, encouraging the development of private banks and credit, and in improving health and education, there have been major shortcomings in all of these respects. For example, the private sectors of these economies have remained weak, without sufficient competitiveness and distorted with inefficient regulations and all too much corruption. Similarly, although education has expanded, it has been of low quality, especially at high levels. Moreover, the constraints put on so many of the favorable developments by the failure of some of these same economies to balance their fiscal budgets and their balance of payments, have greatly limited the full extension of these services and the realization of their benefits. From his very impressive panel regressions for overall economic growth across three different regions (developed, developing and Arab economies) within his 78 country sample, Abdelbary draws some interesting contrasts. For example, he shows especially large positive effects on growth of improvements in technology in Arab countries, suggesting that through improvements in the quality of education (especially at high levels), and improved governance, it could be possible for Arab countries to raise their growth rates significantly through the technology mechanism, in part by inducing more FDI. Similarly, from the especially large coefficient of the freedom from corruption component of governance for the Arab region, and the extremely low values of this index in most Arab countries (which indeed were responsible for the costs to development Arab Spring instabilities), he points to the potential for boosting growth in Arab countries by improving control of corruption. He concludes this highly analytical book with a brief outline of a comprehensive set of political, institutional, economic and social reforms designed to mitigate the existing problems detected in his econometric and other analyses and to promote more inclusive growth in the years ahead. Hopefully, the proposed reforms will be given serious consideration by the people and their leaders throughout the Arab region, so that we may see a brighter path to the development being realized in the coming decades.

Foreword Mahmoud Mohieldin*

The Arab region is in trouble. Some of the world’s worst humanitarian crises have devastated societies, destroyed economies, and displaced millions of people, turning many of them into refugees. The continued marginalization of women and girls and inadequate investment in education and health services hold back social and human development. Water is scarcer than anywhere else in the world, jeopardizing food security and threatening urban and rural development, and climate change have ominous implications for the region, today and in the future. The Arab region is also the only region in the world in which extreme poverty has increased; inequality has also widened. It requires massive efforts and a paradigm shift to be put in track for achieving the Sustainable Development Goals (SDGs). To address these challenges, this rich and ambitious study argues that a bold new approach—based on comprehensive institutional, economic, and social reforms in the region—is needed that dismantles the barriers to good governance and leads to dynamic transformation. Transformative change requires more than just resources, according to the author; it requires a shift in orientation toward a new developmental policy framework in which institutional, political, social, and economic reforms are crafted and implemented simultaneously. Abdelbary’s book is using advanced technical methods in assessing development opportunities and challenges in the Arab region, these tools outcomes were fascinating, especially the recommended framework that has been adequately analyzed in detail across the book. Moreover, the book has very strong policy implications useful for decision makers, which will make it a very useful tool for the assessment and monitoring of reforms. This book fills a critical knowledge gap by presenting a new framework and examining the effects of three exogenous factors resource abundance, conflicts, and demographic change on development. It provokes thinking about alternative scenarios of reforms in the Arab world and raises fundamental questions about

* Dr. Mohieldin, is an economist with more than 30 years of experience in international finance and development. He is the United Nations Special Envoy on Financing the 2030 Agenda. He was the former Minister of Investment of Egypt, and most recently, served as the World Bank Group Senior Vice President for the 2030 Development Agenda. He is also Professor of Economics at Cairo University and a Visiting Professor at several renowned Universities worldwide. He holds leading positions in international research centers and economic associations.

xx   Foreword the region’s prospects. The framework developed in this book could be used to analyze other endogenous and exogenous factors and their impact on the Arab region such as climate change, pandemics, technological change, and the shifts in the center of the global economic gravity towards the east.

Acknowledgements

First and foremost, all praises be to Allah for His blessings for giving me the courage, strength and enthusiasm to complete this work. Sincere thanks and gratitude to those who provided constructive intellect and continued assistance, especially Dr James Benhin for his sincere support and tremendous guidance, I was fortunate to work and learn from him. Thanks to all readers, discussants, fellow panellists and audience members at all conferences and workshops to whom I have presented my work for their insight, comments and suggestions as this project has been reconstructed over the last few years. I owe my deepest gratitude to my wife, who has been steadfastly by my side. My little kids Ahmed and Farida, for being a source of happiness and unconditional love. My great mum and supportive sister; most of what I have achieved in my life is because of their prayers and endless support. Deep thanks to Nick Wolterman and Emerald Publishing team for being enthusiastic to the book idea. Without their support, the project could not have been satisfactorily completed. Finally, I hope this book will bring a lasting impact providing a vision for making our region as we dream. Islam Abdelbary July 2020

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Chapter 1

Introduction Background and Rationale The story of development in the Arab region is very old, and perhaps it started with the earliest human settlements. The great location of the region, mediating the three ancient continents, made it a destination for different commercial movements since ancient times. However, this geographic gift had been coveted by all the grand empires throughout history. After World War II, most of the Arab countries (ACs) got their independence from colonial countries and started mobilising their own resources and utilising them in establishing a new economic, social and political structure. The development process aims to satisfy the basic needs of the people, such as food, clothing, housing, education and treatment and then seeks to steadily raise the level of the well-being of people. ACs have diversity in size, income levels, natural resources, economic structure, human capital, social institutions and economic practices. The overall Arab land area is 44% greater than China, this is 3.8 times the size of the European Union and has half the world’s estimated oil reserves. Therefore, the oil sector has been the dominant driver of economic growth and social development in the region for oil and non-oil exporting. After independence, the ACs’ development paradigm was concentrated on strong governments, centralised planning for social and economic goals and restrictive policies for wealth redistribution. During the 1970s oil boom, the ACs, in particular the Gulf countries, initiated massive public investment in infrastructure and construction sectors. However, this progress encountered real challenges in the mid-1980s because of the collapsed oil prices. Thus, many of the ACs began economic reform programmes in the 1990s and 2000s guided by the International Monetary Fund and the World Bank. These reforms were principally treated with macroeconomic stabilisation and structural adjustment policies. Nevertheless, these reforms were not able to boost the standard living of Arab people and failed to overcome the main barriers of development such as strong dependence on oil, the poor manufacturing base, high unemployment and population growth rates, low levels of returns on investment, low level of integration in the global economy and ineffective of market regulations.

Reviving Arab Reform: Development Challenges and Opportunities, 1–4 Copyright © 2021 by Emerald Publishing Limited All rights of reproduction in any form reserved doi:10.1108/978-1-83982-318-320211001

2    Reviving Arab Reform Besides the fragile economic circumstances, there is a poor institutional structure. According to Freedom House annual reports, the region as a whole had the lowest civil liberty scores, and most of its countries were categorised as partly free or not free. ACs rank among the worst in the global Corruption Perceptions Index estimates. They also noted that corruption is the region’s main threat, as three countries from the region among the bottom ten countries in 2017. In light of the above, politics in the Arab states are characterised by high power concentrated, top-down structural and pure personalised, while economically, the distribution of wealth and income was highly skewed. Under this bleak image of living conditions, a massive wave of demonstrations erupted across most of the Arab world, popularly referred to as the ‘Arab Spring’. The Arab street appeared to have made it clear that it is no longer able to trust these models of development. The central aims of the protesters were easy to capture from their mottoes. The first was ‘the people want to overthrow the regime’ and the second was ‘bread, freedom and social justice’. These slogans reflected what the Arab people looking for. They want more participatory and democratic political structures, a fairer economic structure and an independent judiciary. The first slogan accomplished in Tunisia, Egypt, Libya and Yemen by ousting old rulers, whereas the second, which emphasises the interdependent political, economic and social integration, still require more time to identify alternative solutions and a range of policy options. However, Arab governments have been doing little to address those goals. Almost all governments have failed to implement the deep reforms that were needed to transfer Arab economies from rentier economies into modern and productive ones based on innovation and competition. Many ACs have fallen into the trap of internal and regional conflicts and have turned into struggles between revolutionary forces and old regimes that even if their heads are removed, their followers’ control most of all the state’s joints. They made the post-Arab spring policies just an extension of the same one that led to the revolutions. Therefore, Arab streets have witnessed other several waves of protesting; people have taken to the streets once again in Algeria and Sudan, and they succeeded to remove the autocratic regimes of presidents Bouteflika and Al-Bashir, driven by the conviction that the old system is totally underqualified to address the current moment challenges. Although the triggering demonstrations vary from country to country, the major reason is a pervasive distrust of government performance. People all over the region ask for new developmental approaches that offer considerable priorities to the interlinked matters of political governance, decent employment and social justice. During this critical era for the region, the need for a new strategy of Arab development has become necessary. Under this plan, an economy can transform the available resources into an inclusive growth base that generates suitable job opportunities, reduces poverty, recognises human rights and sees social expenditure as a real investment for the future.

Purpose of the Book The book provides a good opportunity for the interested audience as the findings of the study can be viewed as significant contributions to the ongoing debate

Introduction    3 about reform, economic growth and development. It extends current knowledge and takes an important step towards explaining why some developing countries successfully reform their economies while others fail, as well as identifying the major challenges facing the economic development of the Arab world. This book investigates the effect of reform programmes in the Arab region on development over the past three decades. Following the analyses, the book proposes a new development framework that could be adopted by ACs to help achieving sustainable development and raise the standard of living for Arab citizens. Only a few studies have addressed the Arab region, and often the analysis is conducted within a larger sample of countries with no emphasis on the case of the Arab economies. Therefore, the book has been written specifically for researchers and policy-makers interested in the field of development and growth in developing countries in general and the Arab region in particular. Also, those interested in institutional economics will find much enjoyment in the book, which clearly highlights the role of governance in development and considers it the central pillar in any targeted reforms.

Structure of the Book We start the book with Chapter 2 The Theoretical Basis. This chapter is considered as the theoretical foundation of the book, where we describe the key ideas, components and theories of economic development, starting with the classical school and closing with the ‘New Institutional Economics’. The basis of the book extends to Chapter 3 Methodology, where we present the methodological issues related to the investigation carried out in this research and discuss the methods that underpin the analysis. We also show the econometric techniques, including any modelling issues and problems and provide techniques for solving these problems. The analytical investigation begins with Chapter 4 Insight of Arab Economics: A Reforming Outlook. This chapter explains the origins and drivers of Arab economies’ evolution, determines the pattern of economic growth of the Arab region and compares it to other regions in the world in order to understand the possible explanation of why the growth performance of the region has been disappointing. We also highlight the types of reform programmes implemented in the Arab region during the three decades. The economic features of the reform are evaluated in Chapters 5 and 6. In Chapter 5 Economic Stabilisation and Arab Reform, we explore and assess the factors of the economic stability of ACs in detail during the last 30 years. The macroeconomic stability involves inflation, unemployment, public finance and the exchange rate, whereas external stability includes the current-account balance, foreign debt and international reserves. Chapter 6 Business and Structural Reform completes the discussion of the economic aspect through explaining the structural reform efforts that have been made since the 1990s, which include policies that increase the role of market forces, the liberalisation of the market and bank system, tax reforms, financial sector deregulation and diversity of economic activities.

4    Reviving Arab Reform The social perspective of reform and the social impact of economic reforms are presented in Chapter 7 Social Aspects of Arab Reform. It shows the situation of poverty and inequality in the region and then examines the development of the different aspects of human capital reform in the areas of education, health and scientific research. Additionally, it assesses the provision of public goods such as physical infrastructure and technology needed for sustainable development. In order to complete a comprehensive picture of reform, Chapter 8 Institutions and Political Aspects of Arab Reform explains institutional reform based on the six Indicators of Worldwide Governance. This chapter goes beyond explaining the trends of these factors to cover the root causes of current failure in the Arab governance system. Based on previous explanations, Chapter 9 Winners and Losers of Arab Reforms attempts to classify the ACs based on progress in the structural reform and macroeconomic stability. We also reached an important conclusion to determine that major factors have played the leading role in delaying and undermining reform efforts in the region. The empirical analysis is covered in Chapter 10 The Impact of Reform Programmes on Economic Growth: An Econometric Analysis. The model examines empirically the effectiveness of economic, social and institutional reform programmes in achieving sustained growth through using conditional convergence equation for ACs compared to advanced economies and developing countries. The book recommendations are presented in Chapter 11 Towards an Inclusive Development Framework for Arab Reform. This chapter proposes new frameworks for a comprehensive and integrated development based on the economic, political and social growth for the Arab world, taking into consideration the distinctive features of each Arab group. These frameworks recommend public policies’ practices through a set of transitions that make up the contours of a new development model and outline the fundamental changes needed for making this transition from different perspectives.

Chapter 2

The Theoretical Basis*2 Introduction Development is one of the most controversial issues in recent history. The experience of development research of the past 50 years has proved that development is possible but not inevitable. While few countries have succeeded in rapid growth, squeezing the gap between themselves and the more advanced nations and bringing millions of their people out of poverty, many more economies have seen the development gap growth and poverty increase. The objective of this chapter is to critically demonstrate the theoretical interpretation of development, reform and growth. This chapter will outline the concepts, elements and theories of economic development, starting with Adam Smith and his classical school and ending with the recent theory on development that focusses on institutions, laws and regulations in the area of ‘New Institutional Economics (NIE)’.

What is Development? Economic development, in its simplest form, aims to create the prosperity of a nation. Mainly before the 1970s, rapid economic growth and the size of gross domestic product (GDP) were considered a good proxy for development and its other attributes (Todaro & Smith, 2011). However, improvements in welfare such as better health, education and more housing for poor people are not appropriately captured by the GDP indicator. The experience of the post-World War II found out that many developing nations did reach their economic growth targets. Still, the levels of living of the masses of people remained unchanged, which was a signal that something was quite mistaken in this conventional understanding of development. Several developing countries have experienced high growth rates in terms of per capita income but a limited change in the living conditions of the majority of the population. In other

*

This chapter is based on Abdelbary and Benhin (2019d), which explains in detail this theoretical debate.

Reviving Arab Reform: Development Challenges and Opportunities, 5–13 Copyright © 2021 by Emerald Publishing Limited All rights of reproduction in any form reserved doi:10.1108/978-1-83982-318-320211002

6    Reviving Arab Reform words, while per capita income increased, poverty, inequality and unemployment were getting worse. In the 1990s, the term ‘quality of life’ seemed to be used extensively to determine the degree of development of countries. Diseases, malnourishment and death that happen in the everyday lives of those in the developing countries dramatically changed the view of development goals. By then, many researchers around the world contributed in shifting the development goals set by governments in developing countries to broader objectives. Therefore, there was an urgent need to a more comprehensive perspective of development goals as reflected in the World Bank’s Development Report to improve the quality of life it encompasses as ends in themselves such as better education, higher standards of health and nutrition, less poverty, a cleaner environment, more equality of opportunity, greater individual freedom, and richer cultural life. (World Bank, 1991, p. 4) These changes in development goals highlighted the need to construct alternative composite indices to reflect the quality of life. These directories should take into account not only financial indicators but also non-financial indicators to reflect the development levels achieved. For these reasons, the United Nations Development Programme has published the Human Development Index annually since 1990 in an attempt to provide an aggregate measure of life expectancy, education and income. Over time, the interpretation of development has expanded again to include removing barriers to liberty, such as hunger and tyranny, that leave people with limited choice and opportunity. This humanistic approach to development leads one to explore what constitutes satisfactory minimum living conditions. For example, an acceptable minimum economic standard could include a person’s ability to consume sufficient nutrients to avoid being malnourished and to live in a dwelling with specific essential characteristics (in terms of size, access to improved drinking water, electricity, etc.). By costing this standard of living, the minimum income needed to achieve this standard can be determined. The World Bank currently defines economic development as ‘qualitative change and restructuring in a country’s economy in connection with technological and social progress’ (Soubbotina & Sheram, 2000, p. 96), while the most inclusive definition is given by Todaro and Smith (2011, p. 5) as ‘an increase in living standards, improvement in self-esteem needs and freedom from oppression as well as a greater choice’.

Is It Development or Growth? This study believes that economic growth is only one aspect of any real development and reform process. Growth is a necessary but not a sufficient condition for development because GDP per capita might be rising; at the same time, most people do not see any actual improvements in living standards because poverty

The Theoretical Basis    7 might be increasing, inequality rising and massive environmental damage might be occurring. Economic growth and development have a mutual relationship towards creating a suitable environment, where individuals can strive to enhance welfare, make use of available technology and acquire new knowledge in a secure environment. Economic growth supplies the resources to drive a rise in development and enhancements in human development that guarantees economic progress by the increase in the quality of the labour force. Economic development is the improvement in the standard of living with sustained growth from a deprived economy to an advanced, high-income economy. When the quality of life betters this, it generates development, which includes processes and policies that raise the economic, political and social well-being of the society. The purpose of development policies is to accumulate several productive factors to begin sufficient economic growth that causes improvements in the standard of living, reduces inequalities and increases the welfare of the population. Accordingly, this study defines economic development as the promotion of economic growth in such countries, which results in improving the standard of living factors such as health, education, working conditions, poverty reduction, improved functioning of markets and, in particular, reform of public institutions, which is the core of this study.

A Brief Review of Modern Economic Development Theories Comprehending the main forces behind long-term economic growth has spurred a large body of theoretical as well as empirical research. Identifying the sources of growth and thus, development is critical for the design of economic policies that would lead to sustained growth and thus higher standards of living. On the scene of contemporary economic thought, there are three fundamental theories competing in this regard: neoclassical theory, endogenous theory and institutional theory. The scholars of these three schools argue that their beliefs are more appropriate to explain economic growth and the disparity of wealth among nations. Each group of affiliates recommends specific economic policies that reflect the thoughts of their theories. The following paragraphs introduce a comparison of these theories by highlighting the main characteristics and criticism to each of them.

Neoclassical Theory The neoclassical theory can be divided into three component approaches: the free-market approach, the new political economy approach (Public-choice theory) and the market-friendly approach. These concepts mean that markets alone are efficient, where commodities’ prices are freely determined by supply and demand powers and achieve their equilibrium without government intervention. The neoliberal theory proposes that social justice can be achieved through ‘trickle-down’ effect. The idea is that providing economic benefits to those with

8    Reviving Arab Reform upper-level incomes will ultimately benefit society as a whole through the new wealth being invested into the economy and therefore providing wealth for lowerincome earners (Aghion & Bolton, 1997). Another strand of neoclassical freemarket thoughts, called the traditional neoclassical growth theory originated from the Harrod–Domar, is the Solow and Swan models. Expanding upon the Harrod–Domar formulation, Solow (1956) and Swan (1956) neoclassical growth models emphasised the role of three elements of output growth: increases in the quantity and quality of labour, increases in the capital (through savings and investments) and improvements in technology. Technological change in Solow’s model is incorporated exogenously. Thus, with the same rate of technological progress, the economic growth rate would be projected to converge through countries. Developing countries will attract additional domestic and foreign investment by opening up national markets, thus raising the rate of capital accumulation and return on investment. The developing countries will eventually tend to converge to higher per capita incomes. The Neoclassical School argued that policies of liberalisation, privatisation, foreign trade, private international investments and foreign aid flowing into developing countries could be expected to accelerate the economic efficiency and economic growth of these countries. Empirically, the models failed to produce the predicted performance. Pro capita growth rates have diverged across countries, with the weak and inadequate regulatory framework. Regardless of the different institutional, cultural and historical context of the developing countries, a free market in these countries does not boost economic development.

New Growth Theory (Endogenous Growth Theory) In the early 1990s, the endogenous growth theory has explained the lacklustre performance of several developing countries, which implemented recommended neoclassical policies. Unlike the Solow model, the new growth model claims that technological gain has not been equal in most countries, nor has it been exogenously transmitted. The theory linked the technological change to the production of knowledge. The new growth theory emphasises that economic growth results from increasing returns to the use of knowledge rather than labour and capital. Lucas (1988) argues that the higher rate of returns as predicted within the Solow model is significantly disintegrated by lower levels of complementary investments in human capital (education), research and development (R&D) and infrastructure. Meanwhile, knowledge is different from other economic products as it could grow boundlessly. Knowledge and innovation can be reused at zero extra cost. Therefore, investments in knowledge-building can lead to sustained growth. Moreover, knowledge could create spillover benefits to other firms once they have acquired knowledge. Markets, however, fail to develop sufficient knowledge, so people cannot absorb all the benefits associated with generating new knowledge from their investments. Therefore, policy intervention is deemed necessary to influence growth in the long term (Aghion & Howitt, 1992). The new growth models believed in the development process through promoting the role of public

The Theoretical Basis    9 policies in human capital development and improvement of foreign investments in knowledge-intensive industries such as computer software and telecommunications (Romer, 1990). On the other side, the theory was criticised for ignoring the importance of social and institutional structures. The governance effects on short- and mediumterm growth was ignored because of the new theory’s focus on the long-term growth determinants.

New Institutional Economics (NIE) Theory By the end of the twentieth century, the importance of institutions and governance to development increased notably after the failure of applying the pure concepts of neoclassical ideas in developing countries. Policies such as liberalisation, privatisation and tax reforms created severe instability, inequity and inefficiency. These policies were often carried out without the appropriate regulatory and legal frameworks or government rules and structures and thus make banking systems, corporate governance and tax collection work efficiently only in advanced countries. As written by North (1990), institutions are ‘the rules of the game’ that shape human behaviour in a society. The NIE combines economic theory with the analysis of institutions. The theory focusses on the belief that humans develop to explain their environment and the institutions (political, economic and social) that they create to shape that environment. The NIE does not assert that neoclassical theory is wrong but merely incomplete. It focusses on the evolution of institutions rather than on the limits that they pose to economic development. Consequently, the NIE is linked to development by emphasising the elements of development management such as accountability, publicly known rules, information and transparency. Moreover, the institutional framework needed to provide these public goods must be managed efficiently. Productive institutional arrangements will vary among countries by their cultural traditions and historical relationships. These will also continue to evolve as the economy grows and becomes more complex and more integrated with international markets.

Underpinning Theory of the Research To sum up the above theoretical debate, we have three major theories of development in the economics literature. The first is the neoclassical theory, along with its extensions, which stresses the accumulation of physical and technological change as the ingredients for economic development. This view ignores the impacts of other factors, such as institutions and natural endowments. The second is the endogenous theory of development, which holds that investment in human capital, innovation and knowledge is a significant contributor to development. The theory also focusses on the positive externalities of a knowledge-based economy, which will lead to economic development. The third is the institutional development theory, which suggests that institutional structures establish the incentive system that agents meet in an economy and are thus directly responsible for economic efficiency.

10    Reviving Arab Reform The three theories are not necessarily contradictory but are more likely to be complementary in gaining a more comprehensive understanding of comparative economic development. While the endogenous theory of development contends that human development has a direct impact on economic development, some researchers have argued that the influence on economic performance is indirect through its effect on institutional development (Sokoloff & Engerman, 2000). Therefore, there is the need to account for the three views in advancing a more comprehensive institutional view of comparative development than that existing in the current literature. The ultimate aim of the current study is to design a developmental framework that integrates the traditional factor of development (economic growth) with other endogenous factors of development, such as institutions. NIE theory will be used basically as the theoretical background for the analysis for the reason that it combines the basic concepts of development and is extended by focussing on the social and legal norms that underlie economic activity. Indeed, achieving economic growth without realising the real meaning of development from a macro perspective with poor governance is catastrophic. For instance, a misunderstanding of the concept of development and neglecting governance aspects significantly contributed to the emergence of the popular Arab revolts in 2011. While some of the Arab Spring countries reported high economic growth before the revolts, the wealth did not trickle-down to the average Egyptian, Tunisian or Syrian citizen. The only group that benefitted from this growth was the economic-political elite, which owned and controlled much of the economy (Malik & Awadallah, 2013).

The Theoretical Model of the Research Based on these theories, three theoretical models explain the thought of each one. The first is the contributions of Solow (1956) and Swan (1956), who assume a standard neoclassical production function with decreasing returns to capital. Unlike the Solow model, Mankiw, Romer and Weil from the new growth school show that the Solow–Swan model, augmented to include human capital in addition to physical capital and population growth, provides a much better fit for cross-country data. Finally, the augmented Solow growth model and the total factor productivity (TFP), as societal payoffs to enhancements on the levels of physical and human capital, are probably dependent on the institutional conditions. The first two models focussed on the vital role of physical and human capital in explaining income differences; however, some empirical studies have indicated slight evidence that attempts to raise physical and human capital levels in developing countries, particularly in Africa, have been unsuccessful in generating high growth. Easterly (2001) explains that many African countries have seen higher increases in schooling than any other country since 1960; however, these countries remained mired in poverty, while Asian ‘tigers’ like South Korea and Taiwan had lower increases in education levels but economically flourished. The justifications

The Theoretical Basis    11 of these relations are illustrated by Pritchett (2001), when he found that in some countries, the institutional environment could be so perverse that increasing education actually leads to lower growth. In general, societal payoffs to improvements on the levels of physical and human capital are probably dependent on the institutional conditions, in which those investments occur. In countries with good institutions where the social, political and legal rules provide for protected property rights, fair contract enforcement and reliance on a free-market mechanism to guide economic activity, investments in the capital are both privately beneficial to individuals and also able to create a positive impact on the economy as a whole (Abdelbary & Benhin, 2019c). In contrast, countries with weak institutions have higher returns to investments in rent-seeking activities result in the plunder of the wealth of others, through lobbying of influential members of society in a coalition of military, political, religious and economic elites (North, 2009; North, Wallis, & Weingast, 2008). In this respect, integrating this hypothesis into the augmented Solow growth model is theoretically an apparent extension undertaken by Dawson (1998), who was the first to integrate institutions into the typical growth models and then empirically test this hypothesis by interacting governance with both physical and human capital in cross-country growth regressions. Consider the following production function of Cobb-Douglas that exhibits constant returns to scale (0 < αi < 1 & α1 + α2 < 1) but diminishing returns to individual factors Y = K α1   H α 2 ( A   L )1−α1−α 2 ,(2.1) t t t t t where Yt represents total production, (H) is the stock of human capital, capital (K), labour (L), (AL) is the effective labour and (At) is the total factor productivity (TFP), also known as the Solow residual or the ignorance of neoclassical growth theory. It is designated to capture a host of factors that affect the overall efficiency of the economy. These factors reflect not just technology level but also other factors such as resource endowments, climate, quality of management and governance, the strength of institutions and property rights and cultural factors. Thus, TFP is a composite variable denoting the efficiency and effectiveness of an economy. According to Chenery (1986), the contributions of TFP are 50% of the overall growth in developed countries, whereas this situation indicates 30% of the total growth for developing countries. The TFP implicitly assumes an underlying set of good institutions. In this model, the quality of institutions affects output through the effect that institutions have on the productivity of human and physical capital. Therefore, the notion of institutions affecting TFP can be explicitly incorporated into the model via a function of A, following Hall, Sobel, and Crowley (2010): A =  A   e gt   e B ( Ii −  I * ) , (2.2) t 0

12    Reviving Arab Reform where A0 represents the basic level of technology, eB(Ii-I*) is the total effect that b 2( I i −   I * ) institutions have on the productivity of human and physical capital, h and t *   ktb1( Ii −  I ) , respectively. Here, I* represents the ideal institutions implicitly assumed in the traditional growth model, and I is the country’s current level of institutional quality. Thus, (I − I*) measures the degree to which the country’s institutions fall short of ideal conditions and could be defined as Iˆ . When I = I* or ( Iˆ = 0), with an ideal institutional environment, productive entrepreneurship, investments in human and physical capital and the division of labour are incentivised in a manner necessary to foster innovation and economic growth such that a country is operating on the production productivity frontier (PPF). TFP is here structured to serve as a production deflator for a country whose institutions are less than ideal, (I < I*) or ( Iˆ < 0), which can be thought of as operating at a point inside the PPF(Abdelbary & Benhin, 2019c). ˆ Therefore, if At = A0   e gt + I , Dawson (1998) argues that the specification of the A function in equation (2.2) implies that differences in institutions have an explicit impact on the level of productivity across countries. One important assumption in this specification is that institutions are considered to affect growth via TFP channel and not only via investment term but also through human capital.1 Thus, the growth model based on equation (2.1) and incorporating equation (2.2) can be conveniently derived as to obtain the steady-state income per capita *

Y  α1 α2 ln  t  = ln A0 +  gt +  Iˆt +   ln sk +  ln sh     Lt  1− α1− α2 1− α1− α2

− 

α1+ α2  ln ( n + g + δ ) . 1− α1− α2

(2.3)

Within this framework, institutions exert a homogenous influence on the productivity of human and physical capital across economies. Equation (2.3) presents a heuristic way of testing the institutional effects on growth via its impact on factors’ productivity. This equation can be used to estimate the direct impact of institutions on the level of income per capita and differenced to examine how institutional change affects economic growth.

Looking Back and Ahead In this chapter, we have traced the concepts, elements and theories of economic development, starting with the classical schools and ending with the new institutional theory. We have three schools of thought and they complete each other; the neoclassical theory stressed the accumulation of physical and technological change as the ingredients for economic development. The endogenous theory of development focussed on investment in human capital, innovation and

1

See Dawson (1998) for more discussion on the possible channel of institutional ­impact towards growth and the consequent assumptions made.

The Theoretical Basis    13 knowledge, whereas the institutional theory of development highlighted the institutional arrangements in determining economic performance. Chapter 3 presents the methodological issues related to the investigation carried out in this book and discusses the methods that underpin the analysis in this study.

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Chapter 3

Methodology Introduction This book aims to contribute to the economic development in Arab countries by examining the effects of recently applied reform programmes. Therefore, the primary purpose of this chapter is to present the methodological issues related to the investigation carried out in this research and discuss the methods that underpin the analysis in this study. This chapter contains a full description of the research approach and econometric methodologies, including modelling issues and problems, as well as a discussion of the techniques of solving these problems. A similar approach has been followed in the section describing the data, which provides detailed background information regarding all the data used in this study.

The Research Approach Despite a growing body of literature concerning Arab reform, most studies only provide a general overview without sufficient details. Also, the majority are interested in the economic aspects rather than other dimensions of reform, and the question of the inclusive framework of reform seems not to have received due consideration. Even in the economic perspective, it is remarkable that sectoral and single-issue studies that focus on one point of the reform process dominate the scene (Ahmed, 2006; Harik, 2001; Omran, 1999; A. R. Sabri, 1997; Sayan, 2009; Tekin-Koru, 2009). Furthermore, there is an apparent lack of comparative studies. Although the benefits of comparative methods in the social sciences are beyond doubt, the vast majority of authors seem to ignore this and focus instead on either singlecountry studies or single-sector analyses. The previous studies failed to recognise the region-wide patterns of economic policy reform in the Arab world as a whole. A comparative approach to the study of economic reform would be required to capture those patterns in this part of the globe. What is missing is a truly comparative and comprehensive study that assesses similarities and differences at the origin, execution and output of liberal economic change across the region.

Reviving Arab Reform: Development Challenges and Opportunities, 15–37 Copyright © 2021 by Emerald Publishing Limited All rights of reproduction in any form reserved doi:10.1108/978-1-83982-318-320211003

16    Reviving Arab Reform This study, therefore, employs a comparative heuristic approach to compare the outcomes of reform in the Arab region with those in other world regions. The comparative cross-country analysis is a more appropriate method than cross-country statistical analysis, based on assumptions regarding homogeneity, independence and the representativeness of the sample. However, both the comparative heuristic approach and cross-country statistical analysis are adopted for this study because, together, they provide a more robust approach to understanding the issues examined in the research. While Chapters 4–8 will use comparative analysis, Chapter 10 builds an econometrics model to examine the output of previous chapters. For both approaches, the analysis is implemented at two levels: the external level, comparing the Arab Region to other regions in the world, both developing and advanced; the internal level, comparing the sub-groups of Arab countries. Evaluating the impact of reform in the Arab region is probably the most difficult concern surrounding the reform debate (Hammoud, 2011; Omran, 1999; Pornwilassiri, 2002; Yousef, 2004). This is due to many key issues that remain debatable, such as what is reform? How can we measure improvement? How is economic performance linked to reform? What is the link between reform initiatives and traditional economic indicators? These questions do hinder the evaluation of reform efforts and initiatives undertaken by several Arab states over more than 30 years of reform experience in one way or another. Consequently, the study addresses these questions by creating aggregated reform indicators to capture reform outcomes originating from indicators connected to reform. For instance, economic reform consists of macroeconomic stabilisation and structural adjustment. Each of these represents a set of measurable indicators (economic indicators) that measure the impact of reform and its effect. In order to achieve this, the research defines reform as the policies and actions taken by a government to achieve a significant improvement in the economic condition, aiming to achieve inclusive development and to expand the standard of living of citizens. These policies should be associated with the adaptation of social policies to minimise contractionary effects of economic reform on the poor and vulnerable people. The originality of the research model is through generating aggregated policy reform indicators using principal component analysis. Each principal component or environmental variable represents a group of variables in terms of relativity as presented in the figure of Appendix 3.1. The first component, macroeconomic stability reform indicators (M), includes exchange rate (M1), government deficit (M2), public debt (M3), inflation (M4) and unemployment (M5). The second component is external stability reform indicators (E), which contains current account balance (E1), the ratio of external debt to exports (E2), total reserves in months of imports (E3), diversification index (E4) and terms of trade (E5). Third, the component of structural and business reform (B) consists of foreign direct investment (B1), domestic credit to the private sector (B2) and concentration

Methodology    17 index (B3). Fourth, the component of human capital indicators (H) includes infant mortality rate (H1), health expenditure (H2), school enrolment (H3), life expectancy (H4) and scientific articles published (H5). The fifth component is physical infrastructure indicators (P), which consists of fixed telephone subscriptions (P1), improved water source (P2), access to electricity for a population (P3) and improved sanitation facilities (P4). Lastly, the governance indicators (G) is based on voice and accountability (G1), political stability (G2), government effectiveness (G3), regulatory quality (G4), the rule of law (G5) and control of corruption (G6).1

The Empirical Model The empirical model, which will be in Chapter 10, is primarily based on the augmented Solow–Swan growth model with the TFP, as stated in equation (2.3) in Chapter 2. According to Barro-type regression, the real per capita growth rate is influenced by two kinds of variables: the initial levels of state variables and control variables (Effendi, 2001). The first factor is the initial levels of state variables. The state variables are physical and human capital, as presented in the augmented Solow growth model in equation (2.1). These variables will influence the growth of national income, which is a state variable itself. The evolution of these state variables over time depends on their initial values as well as on the control variables. Thus, initial values of the stock of physical capital, human capital and national income are critical in determining the time path of the national income. For a given initial level of per capita output, an increase in the steady-state level of per capita output raises the per capita growth rate over a transition interval. The second factor is control variables; it influences the time path of the state variables by changing the environment, in which the state variables change over time, such as the ratio of government expenditure to gross domestic product (GDP), the ratio of domestic investment to GDP, indicators of macroeconomic stability, the ratio of external debt to GDP, openness to trade, current account balance, the fertility rates, quality of governance and institution, etc. All these variables guide the movement of the state variables towards their steady-state or target values, which are empirically unobservable. Therefore, combining the above concepts within the production function and in equation (2.1), the real GDP per capita growth is typically regressed on several explanatory variables, as per equation (3.1) and for a set of countries over time as follows:

ln (RGDPGi ,t ) =  α0  + ϕ1ln (RGDPi ,t−1   ) +  θ1 (X i ,t ) +  εi ,t ,(3.1)

where RGDPGi,t represents the economic growth rate i at time t; ln(RGDPi,t-1) is an N × 1 vector of lags of the logs of real GDP per capita and Xi,t is an N × k matrix 1

Refer to Appendix 3.2 for more details on the composition and evolution of these variables, and Appendix 3.3 presented the definition and sources of data of them.

18    Reviving Arab Reform of explanatory variables derived from theories of economic growth ­discussed previously and supplemented with empirically plausible policy variables (control variables). α is an N × 1 vector of constant terms, ϕ is the convergence coefficient and θ is K × 1 vector of parameters. ϕ is the convergence parameter of the countries under study, and it is expected to be negative as it shows the catching-up process by the countries to their steady-state. If the matrix of explanatory variables X is omitted, the model is thus reduced to the absolute convergence model that assumes all countries share the similar steady-state determinants, and in the long run, all countries will converge to the similar level of output. Therefore, the operationalisation of the model then leads to the following form:

ln (RGDPGi ,t ) =  α0  + ϕ1ln (RGDPi ,t−1   ) +  θ1 (Mi ,t ) + θ2 ( Ei ,t ) (3.2) +θ (B ) + θ (P ) + θ (H   ) + θ (G   ) +  ε  ,  3

i ,t

4

i ,t

5

i ,t

6

i ,t

i ,t

where RGDPGi,t refers to real GDP per capita growth, RGDPi,t – 1 refers to GDP per capita in the previous period, Mi,t is macroeconomic stability indicator, Ei,t is the external stability indicator, Bi,t is structural and business reform indicator, Pi,t refers to physical infrastructures indicator, Hi,t is a human capital indicator, Gi,t refers to governance indicator, α0 refers to intercept, θ1 to θ6, ϕ1 are parameters for the principle components or environmental variables, i,t denote country and time, respectively and εit refers to the error term. To control for sample heterogeneity and to be consistent with the literature, three other control variables have also been introduced. These variables reflect differences in the level of technology or in different endowments of natural and human resources, which can be at the origin of significant discrepancies in the ‘natural propensity’ to grow. The evolving demographic situation is controlled through the incorporation of the annual population growth rate (POP). Given the significance of the natural resource sector to many of the Arab countries, especially Gulf countries, oil rents to GDP (rent) variable has also been included in the model. Finally, the empirical literature confirms that high-tech products are the fastest-growing segment of international trade (Srholec, 2007). It is particularly convenient to use the portion of high-tech products in exports (A) as a proxy for the technological capability of a country2 (Gani, 2009). Furthermore, two dummy variables, financial crisis and Arab spring, are created to examine how both events influence the economies of the countries. The impact of the financial crisis is incorporated into the model by using a financial crisis dummy (D1), which equals 1 for years 2008, 2009, 2010 and 0 for other years. Second, the impact of the Arab spring is incorporated into the model

2

Technology is not explicitly incorporated in economic growth models, even as both neo-classical and new growth theorists agree that total factor productivity TFP represents the best measure of technology change and exercises a dominant influence on a country’s growth performance (Ranis & Zhao, 2013).

Methodology    19 by using an Arab spring years’ dummy variable (D2), which equals 1 for years ­starting from 2011 and 1 for years before 2011. Therefore, the modified operationalisation of the model follows this form: ln (RGDPGi ,t ) =  α0  + ϕ1ln (RGDPi ,t−1   ) +  θ1 (Mi ,t ) + θ2 ( Ei ,t ) + θ3 (Bi ,t ) +θ4 (Pi ,t ) + θ5 (Hi ,t   ) + θ6 (Gi ,t   ) + ϕ2 (renti ,t   ) + ϕ3 ( Ai ,t   ) + ϕ4 (POPi ,t   ) (3.3) +ϕ5  (D1i ,t   ) + ϕ6 (D2i ,t   ) +  εi ,t , where renti,t refers to the ratio of oil rent to GDP, Ai,t is to the ratio of high-technology exports to manufactured exports, POPi,t represents the population growth rate (annual%), D1i,t financial crisis dummy, D2i,t Arab spring years’ dummy and ϕ2 to ϕ6 are respective parameters for these control variables.

Scope of the Study Characteristics of the Data The research analyses the trends and directions of the indicators, as well as the relationships between them, and then estimates the economic growth function developed previously, using two main statistical programmes: EViews 10 and Stata 14. The study draws upon multiple data sources for annual time-series data on a host of economic, social, political and institutional indicators for 78 countries from seven different regions representing both advanced and developing economies based on the availability of the data and the equivalent representations of each sample. Amongst these countries, 17 are Arab countries (ARB); 6 are Central and South Asian countries (CSA); 9 are East Asian countries (EAS); 24 are European countries (ECS); 11 are Latin America countries (LCN); 2 are North American (NAC) and 9 are Sub-Saharan Africa countries (SSF). In addition, following World Bank (2006) and Kuncic (2016), which categorised Arab countries in terms of the economic, social, institution aspects, the current study classified Arab nations into four sub-groups according to their natural resources wealth, labour abundance and level of income. The first group is ‘resource-poor, labour-abundant (RPLA)’ or emerging economies (Egypt, Jordan, Lebanon, Morocco and Tunisia); these countries have small or no hydrocarbon endowments, with high availability of labour. The second is ‘resource-rich, labour-abundant (RRLA)’ or transition economies (Algeria, Iraq and Syria); they have significant endowments of natural resources as well as a great size of the labour force. The third group is ‘resource-rich, labour-importing (RRLI)’ economies (the rich Gulf Cooperation Council (GCC) Countries (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and UAE) and Libya)). They are rich in hydrocarbons but have been acting as labour importers in the region. Finally, ‘low-income countries (LICs)’ (Sudan and Yemen); they import labour despite the limited availability of natural resources.3 3

For the list of countries, check Appendices 3.4.1–3.4.5.

20    Reviving Arab Reform Sources of Data The data sources for the research include the following: – World Development Indicators (WDI) is the primary World Bank collection of development indicators, compiled from officially recognised international sources. WDI provides data for human capital indicators and physical infrastructure indicators. – The Economist Intelligence Unit (EIU) Country Data: EIU macroeconomic database is the most comprehensive source of economic indicators and forecasts available. EIU provides data for GDP, macroeconomic stability indicators and external stability indicators. – UNCTADstat: World Statistical Database created by the United Nations Conference on Trade and Development (UNCTAD); this database provides a wide coverage of topics including foreign direct investment (FDI), diversification index and structural and business reform indicators. – The Worldwide Governance Indicators (WGI) is a research dataset summarising the views on the quality of governance provided by many enterprises, citizen and expert survey respondents in industrial and developing countries. The Worldwide Governance Indicators capture six key dimensions of governance.

Missing Data Dealing with missing data was a critical issue in the data preparation stage. The limited availability of some of the economic and social variables in the four databases mentioned above constituted a serious challenge to the study. The issue has been managed through the following procedures: 1. Updating the data from original databases; for example, oil rent is updated from annual OPEC reports (http://www.opec.org/opec_web/en/publications), health variables from WHO reports (http://www.who.int/gho/publications/ en/) and educational variables from the UNESCO database (http://data.uis. unesco.org/). 2. If the data were still missing, the search then moves on to annual national account reports available from local agencies such as ministries or central banks of each country. 3. In very few cases, the missing data were dealt with by statistical methods such as forecasting (random walk, Mean, linear trend, quadratic trend, moving average and smoothing). This approach was based on Allison (2001) and Davidson and MacKinnon (2004). 4. However, the difficult challenge was the shortage of external stability variables for developed countries after 2005, which seemed not to be available online in any databases, particularly foreign debt and international reserves, and in the latest database update in 2017, the whole-time series were not available for OECD countries. To overcome this problem, the author tried to obtain these

Methodology    21 missing data by contacting several agencies such as OECD, Eurostat and the UK Office for National Statistics, but this proved unsuccessful.4 Therefore, two aggregate variables have been created for external stability. The first aggregate variable for developing countries included four indicators: the current balance, foreign debt, international reserve and diversification index, while the second aggregate variable for advanced economies included only three indicators: current balance, diversification index and terms of trade.5 Notably, this classification helped to enrich the analysis of the study comparison between developed and developing countries, as the sample of advanced economies was used as a benchmark for other results from other study samples to find out the causes of prosperity and the obstacles to development.

Estimation Approaches and Econometric Techniques Panel data methods are the preferred approaches for pooled cross-country and time-series data since panel data methods provide more information, more efficiency and less multicollinearity. Panel estimates also provide higher degrees of freedom and are more informative, and biases are substantially smaller than cross-sectional estimates. The technicalities of panel data analysis in this study are based on Baltagi (2008) and Wooldridge (2010). One of the biggest challenges faced in panel data estimation is how to deal with heterogeneity characteristics in the dataset. Barbieri (2006) has noted that the development of heterogeneous panel unit roots and panel cointegration tests have greatly enhanced empirical analysis using panel data. Therefore, the estimation approach involves several stages: first, panel unitroot test is estimated based on Levin–Lin–Chu (LLC) test (Levin, Lin, & Chu, 2002) and Im–Pesaran–Shin test (IPS) (Im, Pesaran, & Shin, 2003) to ensure the variables are integrated of the same order. Second, the panel cointegration technique, based on Pedroni (1999) and Kao (1999), is applied to check whether there is a long-run cointegrating relationship between the variables. The research is especially interested in the group-statistics, which consider heterogeneity. Third, the estimation tests the relevance of unobservable individual effects through Lagrange Multiplier and Hausman tests. The other empirical concern in the study analysis is related to introducing governance variables in regression estimation. Empirical institutional studies invariably encounter endogeneity problems due to causality issue as governance is thought to be endogenous to growth as reverse causation is possible. To tackle this problem, Instrumental Variable (IV) technique is often employed in the context of endogeneity through two-stage least squares (2SLS) regression analysis. In

4

OECD (http://www.oecd.org/contact), Eurostat ([email protected]) and Office for National Statistics ([email protected]). 5 The distinction between advanced economies and developing countries was based on the classification of the IMF.

22    Reviving Arab Reform previous studies, different instrument variables are generated; for example, ethnolinguistic fractionalisation is used by Butkiewicz and Yanikkaya (2006) and Mauro (1995). According to Mauro (1995), ethnic conflicts may affect political instability or probably lead to civil war. The presence of multiple different ethnolinguistic groups is also strongly correlated with worse corruption, as bureaucrats may prefer members of their same group. Other studies utilised settler mortality such as Curtin (1989) and Sachs (2003) who used the pattern of rainfall and the precise vegetation, as they play a significant role in determining the risk of malaria. Acemoglu, Johnson, and Robinson (2001) assume that high mortality will lead the colonies state to become an extractive state, but low death will lead to a stable settlement of Europeans and subsequent development of relevant institutions. They believe that the influence of these early institutions has continued to the present day and determined current institutions while others studies adopted colonial origins, such as distance from the equator, a fraction of the population that speak English and a fraction of the people that speak another European language (Hall & Jones, 1999). In different studies done by Acemoglu et al. (2001) and Acemoglu, Johnson, and Robinson (2002); they argue that both settler mortality and indigenous population density in 1500 can be used as IV for modern-day political institutions constraining the executive authority. In contrast, according to Ahmad and Hall (2017), most of these instruments often ignore country-specific features of economic growth, which may be correlated with independent variables, causing omitted variable bias. Also, endogenous institutions are invariably challenging to be instrumented, as reliable instruments that can be associated only with explanatory variables and not with the error term are indeed short of supply. Concerns have been raised over the use of specific variables as instruments for institutions. For instance, Glaeser, La Porta, Lopezde-Silanes, and Shleifer (2004) claim that ‘the settler mortality and indigenous population density in 1500’ which was used by Acemoglu et al. (2001), are invalid because they are strongly correlated with GDP per capita, and in many cases, Settler colonisers did not bring the quality of their institutions to colonies. In addition, none of all the instrumental variables used previously are adequately appropriate to the Arab countries, the primary concern of this study. In the Arab world, there are limited differences among people based on race or religion. Arab nations have not also been under Western colonisation for many centuries nor experienced different forms of colonialism, such as Spanish or Portuguese, nor did they even have different levels of rainfall as most of the region suffers from a dry climate. Recently, many empirical studies have utilised the Generalised Methods of Moments (GMM) dynamic panel data (DPD) estimation to correct for unobserved country heterogeneity, measurement error, omitted variable bias and endogeneity problems in their growth estimation. GMM methods take the first difference of all variables in the model to eliminate time-invariant country effects and then use the lagged level of endogenous explanatory variables as the instruments. Notwithstanding, in this study, the GMM estimation will only be valid to be applied for the grouping of advanced economies and developing countries based

Methodology    23 on the sample sizes’ criteria, as both of them are ‘short panel’ – the number of countries is higher than the length of the study (N>T) while the rest of the study samples in the whole Arab countries and sub Arab groups are a ‘long panel’ (N