Not Over Yet

Last summer, as the American primary elections were drawing to a close, the two candidates who captured the world’s attention were focused on proposing solutions to the economic crisis. Although they had different approaches, the consensus was clear: the extent of the economic recession was of a magnitude parallel to that of the Great Depression. Significant changes in the macroeconomic policy of states around the world needed to be implemented in order to avoid the cataclysmic effects that the worsening of such a recession would imply.

A year later, the IMF’s chief economist and leading theorist on macroeconomic policy, Olivier Blanchard asks the question: Where are we today? How have different regions dealt with the economic downturn? What progress has been made, and what accounts for the different results between states?

Globally, his answer is a positive one, as his team has increased projections for the overall economy. However, the answer to the question of the status of the economy changes depending on the region in focus. For the Middle East specifically, Blanchard’s predictions were not as promising.

The International Monetary Fund lowered its Middle East growth forecast for this year by half a percentage noting that Middle East economies will expand by 2 percent, compared with 5.2 percent in 2008. The growth forecast for 2010, on the other hand, was raised 0.2 percentage points to 3.7 percent.  The report noted that the decline in their projections was attributed to the dropping of oil prices, which fell from $147 a barrel to between $50 and $60 over the past year. This decrease has lead to a collapse of export revenues for Middle Eastern and North African Oil producers and will consequently impact the foreign investment, remittances and tourism receipts of the region.

In comparison to previous years’ 6% growth rates, the economic performance predicted for the region is negative. However, in the context of the magnitude of the recession and in comparison to other regions, the Middle East and North Africa are fairing exceptionally well. The question that then presents itself, is how do economists account for the resilience of the region and what recommendations have they suggested for the different countries in order to avoid a worsening of their economic situation?

Blanchard argues that the relatively strong performance of the Middle East is greatly related to three causes. First the World Economic Outlook report notes that banks in the region had limited exposure to the toxic assets that have been undermining the financial stability in other countries. Similarly, countries in the region have not been affected by declines in export volumes or withdrawal of capital flows as were other regions with emerging markets. Secondly, the report notes that central banks in the region have employed timely and decisive policy actions, taking advantage of the drop in global interest rates by easing monetary policy. Specifically, in GCC countries where banks have suffered more from the financial crisis, governments have been quick to provide liquidity and capital.  Finally and most importantly, the resilience of the Middle East and North Africa is due to the ability and willingness of the region’s oil exporters to maintain high levels of capital spending by drawing on reserves that accumulated during the boom years.

A major lesson that is being echoed by various economic analyses, can be summarized in Amartya Sen’s advice to developing nations, which he argues need to apply different tools to ride the recession wave successfully. Countries that have been less affected up until now, have had the advantage of booming sectors that are not as dependent on the global economy as other sectors. However, all sectors do have a trade connection, and only timely policy action will prevent these relatively safe areas in the economy to become entrenched in the instability we have seen in other markets. John Thornton, former president of the investment bank Goldman Sachs, has presented a similar recommendation. He explains that no country is the same, so each state in the Middle East and North Africa must assess its tools and employ them as they best see fit in order to overcome the pressures of the recession.

The 6 percent growth rates that allowed these countries to accumulate $1,300 billion in foreign assets are now the basis, or the opportunity, for counter-cyclical fiscal spending. Saudi Arabia, for example, has exemplified the type of original and country-specific economic policy for dealing with the recession as it announced the largest fiscal stimulus package as a share of GDP as well as a $400 billion investment plan over five years. This type of continued spending has allowed the cushioning of the exporter’s economy and it has spill over effects onto neighboring oil importers. The downside to this type of spending is, of course, that the joint external current account of the region’s oil exporters will likely change from a massive surplus to a small deficit.

According to Paul Krugman’s research on depression economics, this is the type of behavior that governments and central banks need to be pursuing. He argues more concretely that “When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly.”  Thus, the fear of deficit that is considered a negative characteristic when the economy is fairing well becomes a necessary sacrifice during a recession, and a sign of sound macroeconomic policy. The same is true, he argues, of the belief that economic policy should be pursued with caution. In the case of a depression, the time lag that is implied by caution, can render eventual policy implementations unsuccessful as market conditions may have worsened.

This assessment appears to be especially pertinent for Middle Eastern countries, although the different economic characteristics of each state will have an impact on how they implement the current understanding of depression economics.  Leading oil exporters, including Saudi Arabia, and other GCC countries, like Algeria and Libya, have sufficient economic reserves to sustain increased spending over a prolonged crisis. Other countries with more limited fiscal space, including Iraq, Iran, Sudan and Yemen, notes the IMF, will have to prioritize or cut state spending and subsidies.

Paula Mejia - The Majalla Editor for Research & Economics