Private Assets and Public Debts: External Finance in a Peaceful Middle East
Diwan, Ishac, Squire, Lyn, The Middle East Journal
AS peace and stability slowly but steadily return to the Middle East, the first set of fundamentals for resuming regional growth--a stable trading environment and a secure investment climate--will gradually fall into place. The remaining elements are domestic reform and adequate external financing. The former has received considerable attention in the literature, both generally and in the specific context of the Middle East. The latter has not, but there is need for a radical rethinking of the role of external finance in the future development of the region. This article examines the levels and types of financial flows to and from the Middle East in order to assess their past contribution to investment and growth, and explores the need for a new approach to external finance. The focus is on the group of countries (or entities) in the Middle East that can expect to benefit economically from current efforts to bring peace to the region: Egypt, Jordan, Lebanon, Syria, the West Bank, and Gaza (which we group together and for convenience call "the Mashriq"), and Israel. These countries also have similar characteristics with respect to international finance: they are net debtors to the rest of the world, they receive large amounts of official assistance, and/or they rely on large unrequited transfers and worker remittances to equilibrate their balance of payments.
During the period 1970-90, net inflows of capital averaged 16 percent of Gross National Product (GNP) in the Mashriq and 14 percent in Israel.(1) These are very high flows by international standards. Indeed, for several countries, capital flows were a more important source of foreign exchange in the late 1970s than exports of goods and services. As such, they had a proportionately large effect on the evolution of these economies, especially on the expansion of the public sector, and have marked deeply their current state of operation. By 1990, capital flows--while still large in some countries by international standards--had shrunk to about 8 percent of GNP in the region. Since 1991, official capital flows have risen to offset the effects of the 1991 Gulf War, but this rise is likely to be short lived.
An exclusive focus on flows, however, misses vital information on stocks--the outstanding stock of debt, on the one hand, and the accumulation of capital abroad, on the other. For the region as a whole, these stocks are estimated respectively at about 80 and 120 percent of regional GNP in 1991. These are large ratios by international standards. In Latin America, for example, the ratio of debt and capital abroad to GNP stood at half and one-third of these levels, respectively.(2) These past legacies offer both an exciting prospect and a difficult challenge. The prospect lies in the possibility of fueling a private sector-led strategy of economic development by attracting capital back to the region. The challenge lies in the debt overhang. Besides the burden that the debt imposes on current resources, the weight of public debt is deterring private investors--both domestic and foreign--and delaying the return of past capital outflows.
In assessing future prospects, therefore, it is important to consider any need for exceptional measures of debt relief as countries move to more market-oriented paths of development. Indeed, as in Latin America, debt relief has become a crucial component of ongoing reform programs. Most debts in the Middle East, however, are bilateral. This means that the Brady Initiative does not hold much promise.(3) The model lies instead with the conditional debt reduction granted by the Patis Club to Egypt in 1990-91, which set a new precedent for linking reduction to reform.(4) An alternative approach--an increase in grants sufficient to offset the outflows related to debt payments-can achieve the same aim and has been pursued in Israel.
EXTERNAL FINANCE, INVESTMENT, AND GROWTH
Net financial inflows into the region have been large on average but variable over time. …