AMMAN, 20 October 2003 — The changing structure of global finance has shifted economic and geopolitical power away from governments and toward capital markets. These markets are continuously looking over governments’ shoulders and have become in effect the judge and jury of economic policy making, rewarding those countries who are fiscally responsible and punishing those who are not.
To attract capital, national economies have no choice but to remain open and soundly managed. Every country in the region has to put reform and strong corporate governance at the top of its agenda. If governments do not have in place an effective legal and regulatory framework that protects the rights of investors and consumers and if governments do not live up to their fiscal promises while their central banks produce excessive liquidity or keep their currencies overvalued, they would be subject to capital punishment. Not only will they fail to attract the required capital funds but may even lose the financial resources they already have.
When Egypt failed to deal with its current account and budget deficits and kept its currency overvalued during the period 2000-2002, a strong reaction came from the financial markets that forced the government to devalue the currency. Financial markets had their revenge also elsewhere in the world, in the Far East (1997), Russia (1998), Argentina (2000) and Brazil (2001). When governments of those countries relaxed their fiscal and monetary policies, maintained overvalued currencies and restricted market forces from correcting existing imbalances, they ended up in a crisis. Most of the countries involved suffered a currency crisis first that turned eventually into an economic crisis.
Those countries who implemented sound fiscal and monetary policies, put in place the right supervisory regime with good legal and regulatory systems, liberalized their trade and capital structures, and empowered their private sectors have enjoyed healthy capital inflows and higher growth rates (e.g. Dubai, Bahrain, Jordan, Tunisia, etc). The presence of a strong leadership to implement change has been instrumental in those countries.
Allowing markets to prevail requires having a set of cultural values that emphasize the virtue of competition, the ability to create and gain in a socially acceptable way, the legitimacy of profits and the importance of freedom of transaction. Spreading a market culture in the region is therefore not only an exercise in economic restructuring, but also an acceptance of the basic values and standards that make the system work.
In most Arab countries there exist a conflict between those who call for unleashing the forces of markets and competition, the globalizers, and those who want to keep such forces under control because they are perceived to threaten the social order, the localizers. Those who support competitive markets argue that such a system creates better growth prospects which eventually lead to more wealth and greater productive employment opportunities but at the expense of less equitable way of life. The process of “creative destruction” usually associated with competitive markets, whereby weak companies disappear and are replaced by stronger more productive ones, is a natural progression that is accompanied by higher transitory unemployment.
However, excessive freedom and market competition if left without regulation can lead to anarchy. Regulatory bodies in telecom, banking, insurance, transport, etc., are needed to insure fair pricing and competition, stem corruption, force accounting transparency and provide a stable socio-economic environment for enterprises to flourish. Free markets can function only if the right combination of regulation, supervision and the rule of law is put in place.
Conditions in the world economy today, with the free flow of goods and services across boundaries, best suit the Anglo-Saxon economic model. This model emphasizes flexible and competitive labor and product markets and the maximization of shareholder value. The European economic model has succeeded at combining growth and equality but at the expense of structural rigidities and higher unemployment.
In the 1970s and 1980s, Japan’s growth model based on high-quality training and lifetime employment helped to solve labor shortages and kept wages under control. Industrial policy during the same period in such countries as South Korea, Indonesia and Thailand among others gave evidence of possible gains that could be derived from focused government intervention. However, the financial crisis that hit East Asia in 1997 exposed the limitations of such a policy in various Asian countries. The unwillingness of the Japanese government to deal with the massive number of bad loans on the books of local banks by allowing the process of “creative destruction” to take its course have seriously hurt the country’s ability to grow.
The East Asian crisis of 1997 underscored the importance of maintaining bank based and market based financing systems. Before the crisis broke, there was no reason to question the three decades of solid regional economic growth, largely financed through the banking system. There was no need for a market-based source of financing, as long as, the ratio of non-performing loans to bank assets remained low.
The need for a “spare tire” became evident when the financial crisis hit the region, pulling its economies down with it. The crisis was less severe in Singapore and Hong Kong where viable capital markets existed. Because the Thai and Indonesian financial systems had mainly banks as financial intermediaries, with the corporate bond market virtually non-existing, the crisis there took such longer period to be resolved, leading to a protracted credit crunch.
Capital markets need to develop to provide an alternative source of funding to bank finance. The presence of excess liquidity in the domestic banking system should not be a reason to delay the development of local bond and stock markets. The argument that banks can provide all the capital that corporates need does not always hold. A viable local bond market would provide “patient capital”, i.e. a new source of financing for corporates where cost of borrowing will be determined by market forces. This would help reduce the over dependence of corporates on bank loans believed to have been a significant impediment for industrial growth in the region.
A review of the Arab region’s financial systems reveals excessive domination by commercial banks. Total assets of Arab banks stood at the equivalent of $613.9 billion at the end of 2002. At the same time, and despite some advances in equity market development, Arab stock markets have remained relatively shallow. The market capitalization of 14 Arab stock markets, tracked by the Arab Monetary Fund, stood at the equivalent of $234.6 billion, or approximately 1 percent of global stock market capitalization. Only 6 out of these markets had a capitalization in excess of 50 percent of GDP, and only 4 in excess of 70 percent. Meanwhile, estimates point to a total of $100 billion in Arab government bonds, in addition to a mere $6.0 billion in Arab corporate bonds outstanding at year-end 2001.
Several Arab countries have been going through a period of transition, moving from economies where public sectors are the dominant players to ones where market forces are seriously taking the lead. Nevertheless, up till now the public sector in most Arab countries remains the largest employer and the largest consumer of goods and services. While public ownership of banks is almost absent in Jordan and Lebanon, it remains dominant in Egypt, Syria, Algeria, Libya, Tunisia, Morocco and to a lesser extent in Oman, UAE, Qatar and Saudi Arabia.
One area where radical change is needed in the perception of the role of the state. This role should be limited to that of a regulator and a facilitator rather than the main promoter of economic activities. In particular, the state needs to constantly monitor and upgrade the legal and regulatory environment in which the private sector operates without stifling independent initiatives or disorienting it through frequent changes. People in this part of the world need to refrain from looking at the state as the benevolent father, always willing to compensate those who fail and ready to serve as employer and lender of last resort.
(Henry T. Azzam is chief executive officer at Jordinvest.)
