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3. Policy Challenges

International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
April 2011
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3.1. MENA Oil Importers: Creating Jobs for the Young Workforce

The ongoing social and political events in the region highlight the urgency of addressing youth unemployment. To boost job creation and enhance the employability of young people, policymakers can in the short term bring forward labor-intensive infrastructure investments, provide tax incentives or credit guarantees to viable labor-intensive small and medium-sized enterprises, and scale up promising training programs, or introduce new well-designed and effective ones. But these measures are no substitute for a comprehensive employment strategy that reorients education to better equip graduates with the skills that employers seek; improves the business and investment climate; and dismantles labor market rigidities that discourage firms from hiring. In parallel, governments should provide effective social protection for workers and job seekers.

Addressing high unemployment is a longstanding challenge for the oil importers of the Middle East and North Africa (MENA). In 2008, unemployment rates in Egypt, Jordan, Lebanon, Morocco, Syria, and Tunisia (hereafter, the MENA6) averaged 11 percent, the highest regional rate worldwide (Figure 3.1.1). In contrast to recent cyclical increases elsewhere, high levels of unemployment are not new to the region: unemployment in the MENA6 has been largely structural, remaining in the vicinity of 12 percent over the past two decades. High labor force growth, skill mismatches, labor market rigidities, large public sectors, and high reservation wages have all conspired to keep unemployment persistently high (see October 2010 Regional Economic Outlook for details).

Figure 3.1.1Unemployment Rates by Region1,2


Sources: International Labor Organization; national authorities; IMF, World Economic Outlook; and IMF staff estimates.

1MENA6 countries are Egypt, Jordan, Lebanon, Syria, Morocco, and Tunisia.

2Total and youth unemployment rates for Morocco reflect data from Urban Labor Force Survey.

3Or most recent earlier year for which data are available.

The high unemployment rates in the MENA6, together with low labor force participation rates—particularly among females—result in very low employment-to-working-age population ratios. At about 48 percent, the labor force participation rate in the MENA6 is much lower than in any other region in the world. The employment-to-working-age population ratio in the MENA6 is also the lowest regional rate worldwide, at well below 50 percent, in contrast, for example, to 70 percent in East Asia (Figure 3.1.2).

Figure 3.1.2Employment-to-Working-Age Population Ratios and Labor Force Participation Rates by Region


Sources: International Labor Organization; national authorities; IMF, World Economic Outlook; and IMF staff estimates.

Unemployment: Largely a Youth Phenomenon

Unemployment in the region is largely a youth phenomenon. The share of youth (ages 15–24) in total unemployment exceeds 40 percent in all MENA6 countries, registering around 60 percent in Egypt and Syria.1 Moreover, at over 25 percent, the youth unemployment rate in the MENA6 exceeds that of any other region in the world–a rate that reaches up to 30 percent in Tunisia and 32 percent in Morocco (Figure 3.1.1). Unusually, education in this region is not a guarantee against unemployment. In fact, unemployment tends to increase with schooling, exceeding 15 percent for those with tertiary education in Egypt, Jordan, and Tunisia.

Quick Wins with Long-Term Benefits: Lessons from Elsewhere

The ongoing social and political turmoil in the region has given urgency to the issue of addressing youth unemployment. Faced with this increasingly pressing challenge, policymakers across the region are struggling to find ways to create jobs and enhance the employability of their young populations. Governments can start implementing measures in the short term that would also have long-term benefits.

Turn infrastructure investment into a vehicle for employment generation. Investment in infrastructure can have a sizable impact on employment generation, even in the short term. For example, evidence from Latin America and the Caribbean suggests that about 40,000 annual direct and indirect new jobs can be created in the short term for every US$1 billion spent on infrastructure projects. Extrapolating these numbers to Egypt and Tunisia, for instance, suggests that 1 percent of GDP spent on infrastructure could generate in the short term as many as 87,000 new jobs in Egypt and 18,000 jobs in Tunisia. To have an immediate effect, policymakers in the region can therefore seek to bring forward viable labor-intensive infrastructure projects that are already in the pipeline, while maintaining fiscal sustainability. Such a policy will not only provide wage employment—including for young people—but will also enhance long-term growth, thereby leading to sustained job creation.

Support private-sector activity through macro policies. To encourage job creation, policymakers can explore the possibility of giving tax incentives or providing credit guarantees to viable labor-intensive small-and medium-sized enterprises, as was done in many emerging markets and transition economies during the global financial crisis. Moreover, removing impediments to access to credit would also help these enterprises.

Scale up promising training programs based on past successes in the region. The region offers a growing range of promising youth-oriented training programs. One such example is the Education For Employment Foundation (EFE), which currently operates in several countries in the region including Egypt, Jordan, and Morocco. EFE works with corporations and industries to assess demand for skills and to provide corresponding tailored training programs for young people. Through both in-class and on-the-job training, EFE has proven successful in providing job seekers with skills relevant to businesses and placing unemployed youth in jobs. For example, 85 percent of program graduates were placed in jobs in Jordan and 86 percent were placed in jobs and internships in Morocco. Policymakers should seek to scale up and replicate such promising programs.

Introduce new well-designed and effective training programs. Given the magnitude of youth unemployment and the urgent need to address it, policymakers may want to initiate new investments in well-designed training programs, in addition to expanding training programs that have shown some success. It is crucial that policymakers act now, given that it may take some time to reap the benefits of new investments. Some lessons can be learned from the experiences of other countries when designing such programs. For example, evaluations of youth training programs in Latin America indicate that those that are demand-driven, offer on-the-job training, focus on both hard and soft skill formation, monitor performance, and perform impact evaluation have a significant positive impact on employment and earnings of program participants.

At the same time, when designing short-term solutions to youth unemployment, governments should ensure that such solutions do not harm the long-term goal of sustainable job creation and productive skill formation. For example, and in light of the ongoing political turmoil and uncertainty, governments may be enticed to quickly create unneeded jobs in the already large public sector. Such a policy, which may be difficult to unwind later, may distort labor market incentives and divert resources away from a potentially more vibrant private sector. As another example, giving subsidies to the educated unemployed youth, while well-intended and providing relief, may reinforce skills mismatches for future labor market entrants if the qualification for such subsidies is based solely on diplomas and credentials.

Pillars of a Comprehensive Job Strategy

In parallel to the measures discussed above, governments need to put in place a comprehensive job strategy aimed at addressing the underlying structural problems. Such a strategy should be based on three pillars: fostering inclusive growth, enhancing skill formation, and providing adequate social protection to workers and job seekers.

Fostering higher and more inclusive growth

Achieving high growth remains key to generating jobs for new labor market entrants. Growth needs to be more inclusive; hence, governments need to create an environment that allows all segments of the population to contribute to and benefit from economic growth, not just a privileged few. Moreover, growth should be led by the private sector, and in this regard, government policies need to support an environment that enables that sector to flourish.

  • Create an environment that fosters a level playing field for everyone. “Growth strategies cannot succeed without a commitment to equality of opportunity, giving everyone a fair chance to enjoy the fruits of growth.”2 What is needed is an environment where people, particularly young people, have equal opportunities to acquire a good education, equal opportunities to compete for high-quality jobs, equal opportunities to become entrepreneurs, and equal opportunities to access credit or purchase land and other production factors. Ensuring greater equality of opportunity and broader sharing of the benefits of economic reform would lay a solid foundation for an inclusive and sustainable improvement in living standards.
  • Improve the business climate. Reforms aimed at creating a business environment more conducive to investment and competition—including streamlining the cumbersome and costly procedures for business startups, strengthening property rights legislation, and enhancing contract enforcement—are key to unlocking the region’s employment potential. Such reforms would also facilitate the movement of educated young workers from low-growth-generating and low-income-earning activities in the informal sector to the formal sector.
  • Reach out to the diaspora. There are large numbers of expatriates from the region in Europe, the United States, and the GCC. In many cases, these expatriates have not only advanced degrees, but also years of experience in competitive environments. Calling on the skilled diaspora and reversing “brain drain” would increase the supply of skilled labor and thereby help domestic economies grow and compete globally.3 Improvements in the business environment, better governance, and better enforcement of intellectual and property rights would help bring back talent residing abroad. The successful experiences of India and Taiwan in luring back the skilled diaspora suggest that such reforms may need to be complemented with specific policy support, such as the provision of tax and financial incentives.
  • Foster trade. Recent empirical evidence indicates that countries in the region have been trading far below their potential (see October 2010 Regional Economic Outlook). Moreover, according to recent analysis by the World Economic Forum, trade policies in the MENA6 are among the most restrictive in the world. MENA6 tariffs—averaging approximately 12 percent—are nearly double those in emerging Asia. Furthermore, several countries in the region rank at the lower end among 139 countries surveyed on a measure of overall trade restrictiveness. By further liberalizing external trade and opening up domestic markets, the region could boost output growth and labor demand. Lowering tariffs, diversifying trade toward fast-growing emerging markets, and increasing intraregional trade would help in this regard.

Reduce skills mismatches by addressing the root causes

  • Realign curricula with private-sector needs. Policymakers should scale up initiatives that better align education with the needs of the private sector. One such promising initiative is Injaz, a partnership between ministries of education and the private sector that gets business leaders to teach marketable skills to high school and college students, including basic business skills, teamwork, leadership skills, and entrepreneurial thinking. Injaz was launched in Jordan in 1999 but now has spread to a dozen countries in the region.
  • Reform university admission policies. The attractiveness of university education across the region suggests using university admission policies to influence skill formation at lower levels of education. Reforming such policies to test a broader range of skills beyond rote learning—including writing skills, critical thinking, and problem solving—would give incentives for students at the primary and secondary levels to acquire such skills.
  • Reform public sector hiring practices and compensation policies. Public sector hiring procedures should place greater emphasis on skills and competition and less on paper qualifications. Governments could introduce interviews and tests that evaluate a broader range of skills, beyond what is currently being tested in universities and schools, including both hard and soft skills. Moreover, strengthening the link between compensation and performance and implementing merit-based promotion policies would also send the right signals regarding skill formation for young people.4

Protect the worker and not the job

The region suffers from overly rigid labor market regulations, when compared to elsewhere. In Egypt, for example, severance payments for established employees amount to 132 weeks’ worth of their final salaries. In Syria and Morocco, the average is 80 weeks and 85 weeks, respectively—much higher than the average of 38.6 weeks in the East Asia and Pacific region and 25.8 weeks in the developed world.5 Such high costs of firing discourage firms from hiring in the first place. Therefore, while such regulations are intended to protect the worker, they in fact impede job creation in the formal sector and contribute to driving firms into the informal economy where young people have limited opportunities for human capital development.

Policy should aim at relaxing rigid labor market regulations, while at the same time preserving the right to collective bargaining and providing effective social protection, including unemployment insurance, for workers. More flexible labor market regulations would help enable the private sector to respond effectively to market signals and would increase the employment response of other reforms such as trade liberalization.

3.2. Moving from Subsidizing Products to Protecting People: Strengthening Social Protection in MENAP

Universal price subsidies—especially on foods and fuels—are common in the MENAP region. They appeal to governments because of their administrative ease, but also create distortions and are not well targeted. Several countries recently introduced or expanded price subsidies (and/or cut indirect taxes) to mitigate the impact of higher global commodity prices. While these steps can serve as temporary stop-gap measures, countries should prepare to replace subsidies with more cost-effective social safety net instruments, especially cash transfers and other forms of income support. Subsidy reform is difficult, but experience shows that countries can take steps to facilitate the process. These include collecting and disseminating information on costs and beneficiaries of subsidies; deploying comprehensive communication strategies; strengthening public sector governance and service delivery; gradually improving the targeting of subsidies, compensating reform losers, and strengthening targeted comprehensive social safety nets; establishing automatic pricing mechanisms; and moving in a regionally coordinated way.

The Cost of Reliance on Subsidies for Social Protection

MENAP countries stand out from comparators in other regions for their heavy reliance on universal price subsidies as a social protection tool (Box 3.2.1). According to estimates by the International Energy Agency, the MENAP region accounted for almost two-thirds of global petroleum price subsidies in 2009. Food subsidies are also widespread, with 17 out of 22 MENAP countries currently providing them.

Data on the budgetary costs of these subsidies—which include outlays for subsidies and foregone revenues—are scarce. An aggregation of IMF country desk estimates suggests that price subsidies in MENAP countries amounted to US$200 billion (7.8 percent of GDP) in 2010. About 15 percent of this amount reflected the cost of food subsidies, and the remainder subsidies on fuels and electricity.

While a comprehensive tally of other social protection spending is unavailable, partial information suggests that social safety net instruments and social insurance play less of a role in the region. In particular, targeted cash transfers and other forms of income support are not used widely in MENAP countries and, where they exist, the resources allocated to them are still relatively small (Figure 3.2.1).

Figure 3.2.1Cost of Price Subsidies versus Cash Transfers

(Percent of GDP, 2010)

Sources: IMF staff calculations; and national authorities.

Price subsidies are also imposing efficiency costs on the region. In 2009 and 2010, MENAP countries passed only 25 percent of the global gasoline price increase on to domestic consumers. For diesel fuel, the pass-through was even less. As a result, average retail fuel prices are much lower than in other regions.

Cheap fuel and food prices induce waste and overconsumption, which can lead to damage to the environment, inefficient investment choices, and competitiveness problems. For example, in countries such as Iran and the United Arab Emirates energy consumption (adjusted for income differences) is more than 50 percent higher than in the United States. In Egypt, price subsidies have reportedly led to the use of bread as animal and fish feed. Price subsidies also encourage socially wasteful activities such as smuggling, black markets, and corruption.

Box 3.2.1Social Protection Instruments

The social policy mandate of a government involves providing social protection to vulnerable segments of the population. Instruments typically used for this purpose include social safety net interventions, price subsidies, and social insurance schemes. Social safety nets are noncontributory transfer programs such as cash or near-cash transfers (e.g., food stamps), in-kind transfers (e.g., school feeding, mother/child complements, take-home food rations), and fee waivers for essential services (e.g., schooling, health care, utilities, and transportation). Social insurance involves benefits that are based on prior contributions (e.g., unemployment insurance and old age or disability pensions).

Taxonomy of Social Policy Interventions

Source: IMF staff illustration.

Because universal price subsidies are typically poorly targeted, their cost-effectiveness as a social protection instrument is highly questionable. For example, the poorest 40 percent of the population in Jordan receives less than a quarter of total spending on fuel subsidies. Food subsidies generally do better in terms of targeting performance, but even for them leakages to the better-off are still quite large (Figure 3.2.2).

Figure 3.2.2Distribution of Subsidies Across Income Groups


Sources: Robert Gillingham and Moataz El-Said, 2005, “Jordan: Distributional Effects of Eliminating Subsidies for Petroleum Products,” Technical Assistance Report (Washington: International Monetary Fund); Javier Arze del Granado, David Coady, and Robert Gillingham, 2010, “The Unequal Benefits of Fuel Subsidies: A Review of Evidence for Developing Countries,” IMF Working Paper 10/202 (Washington: International Monetary Fund); World Bank, 2010, “Egypt’s Food Subsidies: Benefit Incidence and Leakages” (Washington).

The longer-term objective for MENAP countries should be to design and introduce more cost-effective social safety nets and replace price subsidies. Effective social safety net interventions such as cash transfers and other forms of income support can be better targeted—typically about 50–75 percent of spending on well-designed cash transfers reaches the bottom 40 percent of the population. Replacing subsidies with income support would strengthen social protection and free up substantial resources for other priority uses. The latter is important for many oil-importing countries in the MENAP region, which have limited fiscal space. Even for oil-exporting countries for which fiscal space is not an issue, phasing out subsidies will prove beneficial by stemming excessive consumption and encouraging conservation and the adoption of more energy-efficient technologies.

Why Is Price Subsidy Reform So Difficult?

Attempts to phase out subsidy regimes have proven challenging in MENAP countries and elsewhere. Some subsidy reforms, especially in the 1980s and 1990s, led to a reduction in outlays, but attempts were often reversed after meeting (sometimes violent) resistance, or rolled back in the face of large commodity price swings.

Several factors explain uneven progress on subsidy reform thus far:

  • First, there is a dearth of publicly available information about the magnitude and distributional impact of price subsidies, and, as a result, awareness of the fiscal costs and distortions of price subsidies is relatively low.
  • Second, subsidies have created vested interests that are difficult to overcome.
  • Third, resistance to subsidy reform reflects—in part—broader weaknesses in the delivery of public services. In many countries, middle-class households are squeezed because they cannot rely on publicly provided health care, schooling, or utilities. In this context, price subsidies are seen as one of few tangible benefits in return for tax payments, and their removal is, thus, heavily resisted.
  • Fourth, in oil-producing countries, cheap energy is considered an entitlement by many, especially when there is no perception of other resource dividends from the government.
  • Finally, even in cases when subsidies are clearly regressive, their removal can hurt the poor and other vulnerable groups, and mitigation schemes must therefore be developed for the transition.

Steps to Strengthen Social Protection in the Short Term

Today, policymakers in MENAP countries are facing the twin challenges of alleviating immediate social pressures, including those arising from higher food and fuel prices, while also starting a process of more fundamental reform of their social protection systems.

To address short-term pressures, countries in the region have announced a number of mitigation measures (see Chapters 1 and 2). Some countries with existing social safety net instruments—such as cash transfers—have been able to scale these up, but many countries have also expanded subsidies or reduced taxes on food and fuel products.

While the use of these instruments is understandable in the absence of better targeted alternative delivery mechanisms, they should be seen as temporary stop-gap measures until more efficient protection instruments can be put in place. At the same time, better targeted measures such as school feeding programs, fee waivers for public services that cater mostly to the poor (e.g., health, education, or public transport), or labor-intensive public works can be expanded or introduced relatively quickly.

Advancing Subsidy Reform with Broad Ownership

The appropriate structure of strengthened social safety nets and the modalities and speed of fundamental price subsidy reform in the medium term will depend on country-specific factors, including administrative capacity, the political environment, and the macroeconomic and fiscal situation. However, experiences from other subsidy reform episodes (Box 3.2.2) can provide some guiding principles for the design of robust subsidy reform strategies:

Box 3.2.2Examples of Successful Subsidy Reforms

In Mexico, the implementation in 1997 of Progresa (later renamed Oportunidades para la Mayoría), a program that provides cash transfers to the poor on condition that health, education, and nutrition targets (such as regular medical check-ups and school attendance) are met, allowed the government to phase out a number of poorly targeted food subsidies, including the generalized subsidy on tortillas in 1999. Evaluations have confirmed that the transfers, which are based on a combination of self-selection and means testing, are relatively well targeted compared to other safety net programs.

Indonesia more than doubled fuel prices in 2005 and further increased the prices of fuel products by 25–33 percent in 2008. Budgetary savings from the fuel price increase financed a cash compensation program to 15.5 million poor families (this scheme was later transformed into a conditional cash transfers program). Additional compensations to other groups included an increase in the personal income tax threshold, a reduction in tariffs on sugar, and a VAT exemption for agricultural products. As part of the reform, the authorities introduced an automatic fuel price adjustment mechanism. Indonesia’s reform benefited from the availability of a well-targeted delivery mechanism for transfers and a successful communications campaign.

Jordan followed a gradual approach to phase out fuel price subsidies starting in 2005. By February 2008, domestic fuel prices followed international prices via a monthly automatic pricing regime. Mitigation measures included increases in minimum and civil service wages, one-time bonuses to government employees and pensioners with low incomes, introduction of a life-line electricity tariff structure, provision of cash transfers to low-income households, and increased allocations to the National Aid Fund (the government’s social assistance entity). However, in January 2011, due to social pressures, the authorities temporarily suspended the automatic fuel price adjustment and reduced taxes on gasoline, diesel, and kerosene. Overall, the Jordanian experience illustrates the importance of putting in place effective social safety nets as part of price subsidy reforms that can be quickly scaled up, to reduce the odds of reform reversal in case of sudden shocks.

  • Collect and disseminate information about costs and benefits of subsidies. Existing subsidies should be quantified, publicized, and brought on budget so that they are subjected to competition for public funding. In addition, household surveys have to be conducted and published so that the recipients of subsidies can be identified. This will heighten awareness of the cost of subsidies and the merits of reforming them.
  • Develop a comprehensive communication strategy. A review of 40 country experiences between 2002 and 2006 showed that the odds of success in subsidy reforms almost tripled with strong political support and proactive public communications.
  • Strengthen public-sector governance, accountability, and capacity. Resistance to subsidy reform will be lower if there is trust that saved resources are used well by the government. To this end, public financial management should be strengthened, particularly the integrity of the budget and the public investment management process. Net savings from subsidy reforms should be transparently allocated to high-priority projects to build public support. However, in countries with limited fiscal space some of the savings may have to be earmarked for deficit and debt reduction.
  • Improve targeting gradually to make early gains. The transition from a social protection system that is heavily reliant on price subsidies to a comprehensive social safety net where cash transfers and other forms of income support predominate will have to be gradual in most cases, as delivery and targeting mechanisms need to be developed and put in place. However, in the meantime, quick gains from improved targeting can be scored by narrowing the scope of existing subsidies to products that are most important for the poor or capping quantities of subsidized products at subsistence consumption levels. Once delivery mechanisms are in place, price subsidies should be replaced by price-indexed cash transfers, ideally with attached conditions that provide incentives for human capital investment (if administrative costs are not too high). Where cash transfers already exist, these can be enhanced and scaled up from the onset to speed up the process of phasing out subsidies.
  • Provide compensation to losers. Data from subsidy reform experiences suggest that the availability of alternative safety net programs and compensations more than doubles the likelihood of reform success. Measures to protect the poor, those living close to the poverty line, and even parts of the middle class thus need to be considered, at least for a transition phase. Such forms of compensation can be particularly important in oil-producing countries, where large price adjustments are needed and access to cheap energy is considered an entitlement. The ongoing reform in Iran, where substantial in-kind subsidies were replaced by cash transfers that are essentially an oil dividend, is likely to provide relevant insights on this matter (Box 3.2.3). Any compensation should be tangible from the outset of the reform, but ultimately rolled into the redesigned social safety net.
  • Establish automatic pricing mechanisms to help depoliticize price setting. Moving away from discretionary ad hoc pricing of commodities—particularly fuels—should be an integral part of any price subsidy reform. Automatic price adjustment can make price setting less controversial, especially if overseen by an independent regulatory agency. While the ultimate goal should be to liberalize fuel and food prices, there may be merit in adopting a smoothing rule (based on moving averages or price adjustment caps). Price smoothing can help prevent the suspension of price adjustment mechanisms in the face of sudden price increases, while still ensuring full pass-through over the medium term.
  • Move regionally, if possible. A broader—even coordinated—effort in the region to phase out price subsidies and establish better social protection systems could also help ease the resistance to change. This approach could make a reduction in subsidies politically more palatable and would reduce the risk of negative spillovers from isolated reforms (for instance by eliminating incentives for smuggling).

Box 3.2.3Replacing Subsidies with Cash Transfers: Subsidy Reform in the Islamic Republic of Iran

In December, Iran started implementing the Targeted Subsidies Reform Law approved by the Iranian Parliament a year earlier. The substantial—up to 20 times—price increase for all major energy products, public transport, water, and some food items (such as bread) made Iran the first major energy-exporting country to cut indirect subsidies drastically and to replace them with across-the-board cash transfers to the population.

The price increases are estimated to have removed close to US$60 billion dollars (about 15 percent of GDP) in annual product subsidies. The law stipulates that out of the revenue arising from the price increase, about US$30 billion is to be redistributed equally to each household in the first year in freely usable cash, US$18 billion to enterprises to finance their restructuring to reduce energy intensity, and about US$12 billion to the government to allow it to pay for higher energy bills and improve energy efficiency in the public sector.


Despite the dramatic increase in prices, the reform was implemented smoothly. Transfer payments to households have supported demand for Iranian goods and particularly benefited the poor. There are indications that the newfound wealth flowing to Iran’s smaller towns and villages is reinvigorating economic activity. Although it is too early to assess the impact on domestic energy use, early reports indicate energy consumption may have declined by up to 20 percent for some fuels. The impact of the energy price increase on consumer prices has so far been limited by the authorities’ efforts to slow down the pass-through to retail prices through higher imports, inventory accumulation, and administrative measures.

Lessons and Looking Ahead

The smooth implementation of the price reform is owing mainly to the clarity of the reform’s objectives, technical preparation, and extensive communication efforts by the government regarding the benefits of the reform and eligibility for cash transfers.

Looking ahead, reforming Iran’s energy-intensive corporate sector and agriculture to offset the negative impact of higher energy prices on their balance sheet is likely to be the single biggest challenge for Iran. Iranian enterprises will need to change their production mix to more energy-efficient products, and alter their production technologies to reduce production costs. This adjustment process is likely to take several years and require the support of effective macroeconomic and microeconomic policies and incentives. The authorities, well aware of this challenge, are planning to launch a number of programs to assist enterprises in their restructuring efforts.

Iran: Selected Energy Prices(Millions of barrels per day)
Before Dec. 19, 20101From Dec. 19, 20101
US cents/literUS cents/liter
Gasoline regular10/3939/68
Gasoline premium15/5349/78
Gas oil1.615/34
Fuel oil119
Sources: Compiled by the authors from media reports.

The first price applies to rationed quota, the second to quantities sold above the quota. To smooth the adjustment, households and selected industrial and agricultural users are eligible to purchase limited quantities of fuels at the lower price. The low-price quotas are expected to be phased out gradually.

Sources: Compiled by the authors from media reports.

The first price applies to rationed quota, the second to quantities sold above the quota. To smooth the adjustment, households and selected industrial and agricultural users are eligible to purchase limited quantities of fuels at the lower price. The low-price quotas are expected to be phased out gradually.

Prepared by Dominique Guillaume and Roman Zytek.

3.3. The Impact of Financial Development on Economic Growth in the Middle East and North Africa

A key challenge for the MENA region is to generate higher rates of economic growth over the medium term to raise living standards and address high levels of unemployment. Slow growth in MENA over the past three decades can be partly traced to two main financial sector issues. First, several countries in the region lack financial depth and, second, the region as a whole has not fully benefited from the level of banking intermediation on offer, signaling a “quality gap.” Policy should therefore aim to provide a financial infrastructure conducive to bank and financial market development; enhance banking competition by removing entry barriers and improving credit information; reassess the role of state banks; and further the process of financial reform.

A vibrant and dynamic financial sector contributes to a host of improved economic outcomes including mobilization of savings, allocation of resources to productive uses, facilitation of transactions and risk management, and corporate control. In particular, there is widespread evidence that financial depth–the overall scale of bank intermediation and financial market activity–is associated with broader access to financial services and faster and more equitable economic growth.

Financial Depth Is Adequate Overall…

Using two common measures of financial depth—the ratio of private credit to GDP for bank intermediation, and the stock market turnover ratio1 for market activity—MENA countries, on average, do not lag behind other regions. From 1975 to 2008, the average private-credit-to-GDP ratio for MENA was substantially higher than the emerging and developing country (EDC) average (Figure 3.3.1), although it has fallen short of East Asia and the Pacific since the early 1990s, and is well below that of high-income countries. As of 2008, the private-credit-to-GDP ratio stood at 45 percent in MENA, compared to an EDC average level of 38 percent. Stock markets in MENA also appear to be deeper, on average, than in other emerging and developing countries, with a turnover ratio of 40 percent in 2007,2 substantially higher than the EDC average of 26 percent (Figure 3.3.2).

Figure 3.3.1Private Credit by Deposit Money Banks/GDP

(1975-2008, percent)

Sources: IMF, International Financial Statistics; World Bank, Database on Financial Development and Structure, 2010; and authors’ calculations.

Figure 3.3.2Stock Market Depth by Region

(2007, Turnover Ratio: Value of Shares Traded/Capitalization)

Sources: World Bank, Database on Financial Development and Structure, 2010; and authors’ calculations.

Of course, notable heterogeneity exists within the region. The high-income oil-exporting economies of the GCC exhibit markedly deeper financial sectors, with an average turnover ratio of 54 percent in 2007, compared to 26 percent for the rest of the MENA region. At the individual country level, while Saudi Arabia is relatively deep on both fronts, with a private-credit-to-GDP ratio of 39 percent and a turnover ratio of 131 percent, Yemen’s private-credit-to-GDP ratio is 8 percent (Figure 3.3.3).

Figure 3.3.3Financial Depth in MENA Countries

Sources: IMF, International Financial Statistics; World Bank, Database on Financial Development and Structure, 2010; and authors’ calculations.

…But Banks Have Not Delivered

However, banking systems in the MENA region have not produced the expected growth-enhancing benefits commensurate with their depth, signaling a quality gap with respect to the rest of the world. First, the region has fallen short in providing access to financial services for the population. Survey results indicate that, compared to other regions, MENA businesses—particularly small and medium-sized enterprises—have received substantially less financing from banks, and perceive this lack of financing to be a serious constraint to business expansion.3 Loan concentration tends to be greater, and the percentage of the population with access to bank deposits tends to be lower. Second, a recent study shows that competition within MENA banking systems has lagged behind that of other regions—partly explaining the lack of access described above—and that it is largely attributed to more stringent entry restrictions, a weak credit information environment, and a deficient level of development of nonbank sources of finance.4

As a result, the impact of banking depth on growth in MENA is weaker than in other regions. An analysis of the determinants of economic growth across a broad sample of countries reveals that, for a given level of private credit, the impact on economic growth is about a third lower than in other EDC regions. For example, if Yemen’s banking system were to deepen to the EDC average, annual per capita growth would increase by 1½ percentage points, while a non-MENA country with a similar initial depth—Armenia, for example—would increase growth by 2⅓ percentage points per year (Figure 3.3.4). The difference, of about ¾ of a percentage point, is the result of the quality gap, or the lack of access and competition in MENA banking systems. Moreover, even for MENA countries with above-average and continuously increasing depth, there is a measurable loss of economic growth due to the quality gap, of up to ¼ of a percentage point per year.

Figure 3.3.4Growth Impact of Raising Credit/GDP to Emerging Country Average

(Average annual percentage points, per capita real GDP)

Sources: National authorities; and IMF staff estimates.

Policy Actions Going Forward

The sweeping changes currently taking place in the region provide an opportunity to introduce far-reaching reforms in the financial area. In order to promote economic growth, policy actions should be directed toward increasing financial depth—particularly in countries where it is most lacking—and enhancing the quality of banking intermediation. Successful implementation of these policies will help increase access to finance, both to households and to SMEs. These policies include:

  • Improving legal frameworks that protect creditor and minority shareholder rights, streamlining insolvency regimes, removing excessive controls on credit and/or interest rates, and maintaining macroeconomic stability, which have been effective in encouraging financial deepening throughout the world.
  • For both deep and shallow systems in the region, enhancing competition will be crucial to improving the quality of intermediation and strengthening bank governance. The relaxing of stringent entry restrictions, to both new domestic and foreign banks, and actions to improve the credit information environment—including the introduction or strengthening of a credit registry—will play an important role.
  • In some MENA countries, the role of state banks should be carefully assessed—and, if necessary, scaled down.5 Worldwide analysis has shown that a dominant state bank presence is associated with lack of financial deepening and, when combined with institutional weakness, with higher governance-related problems and lower economic growth.
  • Government actions to kick-start financial market development, by placing government debt domestically on open and voluntary markets and encouraging development of a secondary market, would also support greater competition by providing alternative channels of financing to banking.

Prepared by Yasser Abdih.


The share of youth in total unemployment refers to data for 2008 or latest earlier year available. The source of the data is the International Labor Organization, except for Jordan (Department of Statistics).


Commission on Growth and Development, 2008, The Growth Report: Strategies for Sustained Growth and Inclusive Development, p. 7.


Marcus Noland and Howard Pack, 2007, The Arab Economies in a Changing World (Washington: Peterson Institute for International Economics).


See, for example, Djavad Salehi-Isfahani and Navtej Dhillon, 2008, “Stalled Youth Transitions in the Middle East: A Framework for Policy Reform,” Middle East Youth Initiative Working Paper No. 8 (Dubai: Middle East Youth Initiative).


Navtej Dhillon and Tarik Yousef (eds.), 2009, Generation in Waiting: The Unfulfilled Promise of Young People in the Middle East (Washington: Brookings Institution Press).

Prepared by Andreas Bauer.

Prepared by Adolfo Barajas (IMF), Ralph Chami (IMF), and Reza Yousefi (University of Texas at Austin).


Other indicators have frequently been used to measure financial depth, but these two indicators have proven to have a stronger and more robust relationship with economic growth. The turnover ratio is defined as the ratio of the value of shares traded to market capitalization.


Country coverage of the turnover ratio declines notably after 2007.


Based on the World Bank Enterprise Surveys, which indicate that 30 percent of firms in MENA are receiving a loan or line of credit from a bank, compared to 33 percent for the EDC average, and 35 percent of MENA firms identify access to credit as a major constraint, for which the region ranks second to sub-Saharan Africa.


Diego Anzoategui, María Soledad Martínez-Pería, and Ricardo Rocha, 2010, “Bank Competition in the Middle East and Northern Africa Region,” World Bank Policy Research Paper 5363 (Washington: World Bank).


Roberto Rocha, Subika Farazi, and Eric Feyen, 2011, “Bank Ownership and Performance in the Middle East and North Africa Region,” Unpublished (Washington: World Bank). This study shows that state banks in MENA follow three mandates (government financing, employment, and development) that come at a cost: lower profitability, higher operation costs, and lower asset quality than their private counterparts.

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