By Rabah Arezki, Chief Economist for Middle East and North Africa Region at the World Bank and Lemma W. Senbet, The William E. Mayer Chair Professor of Finance, Robert H. Smith School of Business, University of Maryland, and Immediate Past Executive Director/CEO, African Economic Research Consortium
To overcome current challenges and seize the opportunity to leapfrog, the Middle East and North Africa (MENA) region needs to simultaneously embrace the technological tide transforming the global economy and clean energy development. This transformation calls for a dual transition: (a) decarbonisation of the economy—moving away from the use of fossil fuel as the main source of energy toward renewable energies; and (b) digitalisation— the digital transformation of traditional activities and the advent of new digital activities. To achieve the transition, MENA needs hundreds of billions of dollars of investment in quality projects, including in renewable energy and telecom sectors. MENA should aggressively join the global momentum for the use of clean, renewable energy (e.g., wind, solar, geothermal) to combat climate change. Likewise, it should aggressively develop the digital infrastructure that is also essential for the development of a digitised financial economy.
Because the availability of public funds is limited and with debt reaching dangerous levels, countries in MENA must undertake upstream reforms, including those pertaining to the macroeconomy and competition needed to attract private investment. There is real opportunity for developing countries, including MENA, to tap into trillions of dollars of “frozen assets” invested in low-yielding, even money-losing, instruments in advanced economies. To attract these funds from advanced economies, MENA must transform its financial system to more effectively channel both foreign and domestic savings into transformative investments at home. MENA needs to unleash the power of the rising pent-up domestic and regional demand to build productive systems that will drive investment and employment creation. Specifically, MENA countries need to take two actions: (a) vigorous enforcement of competition policies especially in the financial system, and (b) adjustment of the macroeconomic policy stance, including exchange rate adjustment. This will not only potentially increase the volume of credit, but also foster efficient allocation of credit and other sources of finance, including non-bank services, toward productive activities that are value enhancing for the private sector, as well as the overall economy.
But it is appropriate to ask why focus on finance for MENA? The current financial system in the MENA region reflects the oversized role of the state in the economy and its crowding-out effect on small and medium-size enterprises (SMEs). The system is heavily skewed toward banking relative to non-bank services, such as stock and corporate bond markets, with significant heterogeneity across countries in the region. The macroeconomic policy stance, including overvalued exchange rates, has adverse impacts on the destination, profitability and quality of bank lending. Moreover, it has hampered the evolution of a deeper and well-functioning financial system that includes non-banking services. Rather what we observe is an entrenched and dysfunctional banking system that mainly channels credit to the government sector but does not perform the vital intermediation role through private credit provision.
The entrenched incumbency of banks is cause for concern, since it stifles the innovation needed to develop a financial system that is dynamic, inclusive, and innovative, and that leverages new technology. In particular, it has limited the role of non-bank operators in promoting market contestability and in developing fintechs, which are growing rapidly, even in low-income countries, such as those of Sub-Saharan Africa. These are all barriers to the development of well-functioning financial systems that help spur economic growth and employment creation.
It is high time for the region to answer the call to break with the status quo and adopt a “moonshot approach” focused on the foundations of a digital economy that supports a well-functioning, inclusive and innovative financial system. Nearly nine years after the Arab revolts, the MENA region is at a crossroads. Throughout the region, citizens have again taken to the streets. Although the triggering events of the protests vary from country to country, as does their intensity, the fundamental cause for all is a pervasive distrust of government. Young people in MENA countries are in despair and lack confidence in the ability of governments to improve livelihoods. These protests signal the need for transformative economic and social changes to spur inclusive development for the creation of jobs for millions of young people who will enter the labour market over the next decades.