The reform agenda that you face is broad, but fiscal policy is a foundation. Expenditure policy in particular has an indispensable role in supporting and seeding the sustainable and inclusive growth we all desire.
With this in mind, let me give you a brief overview of the regional economic context before I single out some of the key expenditure challenges facing the region, and try to offer some suggestions on a reform path forward.
Christine Lagarde Managing Director, IMF[/caption]
The Economic Context
First: the context. As you all know, the global economic recovery has strengthened and growth at a pace of 3.9 per cent in 2018 and 2019 is back on, with 75 per cent of the world economy sharing in the upturn. Yet this tide is not lifting this region enough.
Of course, there are differences among countries. For oil exporters, oil prices have rebounded to half-way between their lows and their highs from a few years ago, which is still putting significant pressure on fiscal balances and it calls for a different economic model.
The story is a little different for the oil importers. Here, growth is expected to rise, but nowhere to near what is needed to provide enough jobs for the young people joining the labor market.
Public debt has been on the rise, exceeding 50 per cent of GDP in many of these countries. In addition, some countries are dealing with conflicts, terrorism, large inflows of refugees, and heightened security risks. So, there are big challenges all around. Stability is ultimately at stake. Youth unemployment is the highest in the world — averaging 25 per cent, and exceeding 30 per cent in nine countries.
Moreover, over 27 million hopeful young people will join the workplace over the next five years, anxious to be included. But so far their aspirations are unfulfilled, and their understandable frustration is compounded by perceived unfairness. Surveys find that more than 60 per cent of people believe that connections matter far more than qualifications for getting a job. This could easily lead to dissatisfaction, a rise in social tensions, and a collapse in social trust.
Key Fiscal Challenges
Against this backdrop, let me turn to the fiscal dimension. The bottom line is that unless fiscal policy is on a sustainable path, rising debt will weigh on already overburdened young people, and there will not be space to fund the spending needed for inclusive growth.
Revenue was the focus of last year’s Forum. Many countries have undertaken important reforms on the revenue side, including the recent introduction of a VAT in Saudi Arabia and the UAE. This is an important step towards diversifying revenue and building tax capacity. There is of course scope to do more as domestic revenues are very low, averaging only 10 per cent of GDP. This must be done with equity and fairness in mind—both of which are conditions for the acceptability of taxation.
This year we focus on the other side of the coin, expenditures. Revenue and expenditure policies complement each other and should be evaluated jointly as a package to achieve fiscal, economic, and social objectives.
If we look at spending, it tends to be quite high in the region — this is especially true among the GCC countries, where it is significantly above the emerging economy average, and approaches 55 per cent of GDP in some countries. While the size of government depends on societal preferences, a high level of spending can easily outstrip the capacity to raise revenue.
Many countries are indeed taking steps to contain spending. But this is too often based on across-the-board reductions or ad-hoc cuts. A more strategic approach that protects the poor and the productive capacity of the economy is preferred.
Let us now consider the composition of spending: The priorities for sustainable and inclusive growth include public investment but also areas such as health, education, and social protection — areas where spending tends to be low in the Arab countries. In other areas, such as energy subsidies and public wage bills, spending is high.
There is really no excuse for the continued use of energy subsidies. They are extremely costly — averaging 4.5 per cent of GDP among oil exporters and 3 per cent of GDP among oil importers, despite lower oil prices. They lack transparency —subsidies are often implicit and off budget. They are vastly inequitable —favouring the wealthy who consume a lot of energy. Perhaps worst of all, they are subsidizing environmental harm at a time when we need to go in the opposite direction — to protect the planet and peoples’ lives, health and futures.
What about the public wage bill? I appreciate that government jobs can serve as a significant social “safety valve.” Yet when the public sector supports every fifth job, this comes with tremendous costs — for fiscal sustainability, for the development of a dynamic private sector, and for governance.
Such challenges are not unique to the Middle East. Many countries around the world have faced the need to reform their large or rapidly growing public wage bills. Careful design of reforms allowed some countries, including, Ireland to reduce its public wage bill by 4 percentage points of GDP. We look forward for Robert Watt, one of the key architects of the Irish reform, to share its lessons.
Ultimately, the common good is ill-served by a system of patronage that hurts productivity and heralds privilege, by the corruption that comes from putting cronyism ahead of capability. This system disposes of good talent, and it reduces incentives to invest in skills and knowledge — the drivers of long-term growth. It can magnify the sense of dissatisfaction, distrust, and resentment — and it is ultimately self-defeating.
Finally, the current pattern of spending remains inefficient across different sectors, including in health, education, and public investment. High wage bills have failed to improve the quality of public services. Nor is public investment delivering in line with expectations, as shown by several Public Investment Management Assessments.
All of this leads to subpar social outcomes. Life expectancy in the Arab countries is about ten years below the OECD average. School enrolment is still not universal, too many girls are still being kept at home, and student performance on standardized tests is among the lowest in the world. The poverty rate is relatively high and inequality remains a concern.
These are daunting challenges. But they are not insurmountable. Good progress has been made in phasing out energy subsidies. All oil exporters have raised domestic prices, with many committing to do more. Oil importers have also made progress.
The bottom line is that the region is off to a promising start on energy subsidies, but there is still a long way to go — especially by depoliticising fuel price setting and introducing automatic pricing mechanisms.
The second reform area relates to reducing pressure on the public wage bill. This will include better aligning wage levels with those prevailing in the private sector and moving away from the embedded system of state patronage. If done right — and with the right social protections — this could help unleash greater innovation and ingenuity in the private sector, tapping into the amazing potential of your young people.
But wage bill reforms should be conducted carefully and strategically. They should take place within a broader expenditure policy agenda, linked to deliverable social goals, including the Sustainable Development Goals.
They should be as equitable as possible, and include early social impact analyses. And they should take place within the broader context of diversifying the economy, reducing corruption, strengthening social protection, and making the business environment more conducive to the creation of decent well-paying jobs.
There is also scope to improve the efficiency of spending. These gains can be significant. In health, for example, worldwide spending inefficiencies subtract more than two years from healthy life expectancy — reducing them by 10 per cent gets you the same benefit as boosting spending by 0.7 per cent of GDP.
[Excerpted from the address of the IMF Managing Director at the 3rd Forum of Public Finance in the Arab States, held in Dubai, last week]