Djavad Salehi-Isfahani
The future
of capitalism in the
Middle East
The future of capitalism in the Middle East will be strongly influenced by
three key issues: how the region reassesses its faith in the role of a strong
state in solving the problems of economic development, whether Islamic
parties are seen as offering a new model of development, and whether the
region succeeds in expanding its global links beyond oil.
In the aftermath of the Arab Spring, the Middle East is deeply involved in a re-examination of its past models of development. With the socialist models all but gone from the
horizon, these societies will be looking to other concrete models of development – the
liberal market-oriented model of Turkey and the populist Islamic regime in Iran – and
to ideals being offered by Islamic parties in their own
Djavad Salehi-Isfahani is professor of Ecocountries. Which way they decide to go depends in
nomics at Virginia Tech and non-resident
large part on how they assess the failures of the syssenior fellow at the Brookings Institution.
tems they are replacing. Do they blame the failures on
He is also a research fellow at the Economic
liberal market reforms that a few of the countries seResearch Forum in Cairo.
riously embarked on, or do they blame the strong role
of the state, meaning too little or too much capitalism?
THE FAILURE OF “DEVELOPMENT STATES”. Belief in the role of the state
as the agent of progress manifested itself in the rise of Arab Socialist thinking that
emerged in the middle of the last century; in the post-independence period the state
was seen as a solution to underdevelopment. Strong states – which called themselves
socialist, but had little in common with regimes in Eastern Europe and the Soviet
Union – emerged in Algeria, Egypt, Iraq and Syria as champions of economic development. Even the region’s old monarchies, such as Jordan, Iran, Morocco and Saudi
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Arabia, reinvented themselves into “development states”, expanding their roles in the
economy, planning and administering economic development.
The common features of all these state-led development systems were extensions of
basic services to ordinary citizens (especially education and health) and employment
of educated workers in their expanding bureaucracies and public enterprises. While
these systems succeeded by and large in improving education and health, they failed
as capitalist systems. Their inefficient public bureaucracies and enterprises employed
millions of educated workers, but could not keep up with the rapidly expanding cohorts of graduates, leaving millions of new job seekers unsatisfied. The inability of
these economies to find productive employment for their rapidly expanding supply
of educated youth is their most glaring failure. Indeed, it stands as the single most
important cause of the discontent that has swept the region.
These governments’ failure went beyond their inability to fulfill expectations of public
sector jobs as rewards for education. By linking education to government jobs, they
distorted the most important promise of market systems, which links skill formation to
rewards in the labor market. Instead of viewing jobs as a reward for skills acquired in
104 education, citizens came to view jobs as rewards for education certificates. The famous
guarantees of public jobs for high school and university graduates – made explicit in
Egypt and Morocco, and implicit in other countries of the region – fostered this distorted view of the labor market. Coupled with expanding free higher education, a crisis
of credentialism developed. This now engulfs the systems of education as well as the
labor markets in many countries in the Middle East.
This approach to education is inherent in the logic of public sector employment, where
the link between productivity and skills is weak and where degrees and diplomas take
on a much greater role. The problem is exacerbated then by the fact that public jobs
come with lifetime tenure, discouraging any post-employment learning. In contrast,
private employers bestow little value on certificates, preferring to evaluate the productivity of their employees themselves; the private sector also requires some flexibility in
wage setting, hiring and firing. State capitalism did little to instill any of these values.
Instead, it promoted job security over productivity, painting in a negative light the private sector’s discretion in setting wages and its freedom to hire and fire employees. It
failed to reconcile the desire for job security and fairness with the needs of employers
to make unencumbered decisions about employees. If liberal capitalism is to prevail
in the region, the challenge in coming years will be to redefine the notions of economic
justice in such a way that it is compatible with private employment.
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In some countries – notably Egypt and Tunisia – liberal market reforms were introduced in the 1990s. Inefficient public enterprises were privatized and the scope for
private capital expanded. But reforms saw the private sector as an inferior partner of
the state in economic development, and no partner at all in political development: this
ultimately led to crony capitalism. In Iran, where market reforms have been moving
in fits and starts, the availability of oil revenues continue to subordinate the private
sector to the will of the state.
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IS ISLAM A SOLUTION? With the failure of state-led capitalism and diminishing rewards from globalization, many intellectual and ordinary people have gravitated
toward Islam as an indigenous model for organizing society and achieving economic
development. It is felt that Islam could bring about needed change without incurring
loss of identity. Islam, as a religion, offers instructions to guide the spiritual life of its
adherents as well as to organize collective economic activity. Early Islamic societies
benefited from adopting the rules set in the shari’a regarding commercial activity. For
example, the rules for forming partnerships enabled wealthy individuals to pool their
resources to engage in specific commercial ventures, which helped long distance
trade flourish in the Muslim world. But, as Timur Kuran has argued in his book,
The Long Divergence, these rules, in conjunction with inheritance laws that demand
the division of property of a partner, ended up becoming a barrier to innovation in
financial institutions; they kept individuals from investing their wealth in productive
enterprises that last beyond their lifetime, such as in a corporation.
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Interestingly, the two strands of thought that still pervade Middle Eastern societies
– Arab socialism and Islamic economics – are each concerned with only one of
the two most important pillars of capitalism: the markets for credit and labor. Arab
socialist policy, at its root, was about who people worked for, not about how work
was organized or how the fruits of labor were shared in society. Indeed, the term
“state capitalist” rather than “socialist” was thus often employed to describe the
economic systems of Algeria, Egypt, Iraq or Syria, even as they formally labeled
their own states “socialist”. By contrast, Islamic economics has little to say about
the employment aspects of capitalism; it has instead mostly concerned itself with
how financial markets are organized. Today, Islamic banking rather than Islamic
business or factories is what makes the Muslim world’s capitalism “Islamic”. Islamic
banking has flourished, and seems to have weathered the recent financial crisis
better than Western financial institutions. (Nevertheless, the imf report card on their
performance is mixed, and there is doubt about what they actually contribute to the
economic development of the region).
On the other hand, the protests that have toppled three Arab regimes and that contin106 ue to threaten others, was not about malfunctioning financial markets. To the extent
that they were about economics at all, they seemed to emphasize the failures of these
regimes in providing jobs – especially for educated youth – and in distributing the
fruits of their not inconsiderable economic progress. For decades, in much of the
Middle East, strong authoritarian states played the major roles in their economies.
In some, such as Egypt and Tunisia, the regimes opened their economies to liberal
pro-market policies while keeping the lid closed on politics. In Syria, both a closed
economy and a closed polity was the rule. In Libya, the role of the state in the economy
went little beyond dispensing oil revenues, either as infrastructure, as compensation
for state employment, or in direct income transfers. All these economies have failed
in two fundamental ways: they have not provided opportunities for employment nor a
level playing field.
POPULIST CAPITALISM. Although in all these countries the failures were those
of a distorted kind of crony capitalism – some would say no capitalism at all – in the
aftermath of the uprisings, the system that will triumph may not be a more liberal and
competitive version of capitalism, but a populist one.
The Islamic parties that swept the elections in Tunisia and Egypt have been careful
not to say anything that would make their already weak economies worse. In a new
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fluid situation, in which masses of poor citizens feel empowered, they are worried
about meeting the demands from the street. Islamists may want to follow a moderate
path and give private enterprise a second chance, but if the new social contract fails
to deliver for the poor, these governments may turn to populist policies.
What governments can do in terms of new shari’a-compliant rules for the financial
markets is unlikely to make a big difference. Creating employment in these countries
is not a matter of improved banking regulation, it requires investment by the private
sector. In fact, changing the banking rules to eliminate interest is relatively easy. In
Iran, where a populist government has been in power for the last three decades, interest rates are officially banned, and all credit must carry some element of risk-sharing
as required by the shari’a; however, banks are allowed to advertise “guaranteed profit
rates”, which everyone treats as interest. The fine print is all that is required for the
clergy to give their stamp of approval to the new legal arrangements that define what
is called “Islamic banking”.
SOCIAL JUSTICE. There is a large gap between the aspirations of the triumphant
Arab youth and the reality of the region’s economies. Their aspirations are for better 107
and more jobs, while the private sector needs less restriction on its hiring and firing.
They want a system that is more fair but their notions of fairness are at odds with
those that prevail in capitalist societies. A glaring example of this contradiction was
the fight over the minimum wage in Egypt. Demonstrators asked for a minimum salary of about $300 per month at a time when employment opportunities in Egypt were
shrinking and private employers were not inclined to invest. The challenge here is to
find a social contract in which private capital feels wanted while workers are assured
of decent jobs.
Two key components of such a new social contract – that are consistent with capitalism and that can satisfy desires for security and equity – are to replace job security
with income security and the concept of “equal outcomes” with that of “equal opportunity”. Job security places the burden of income security on the labor market and
private employers; this, in the competitive global economy, means less capital and
fewer jobs. By shifting the burden to the state in the form of unemployment insurance
and safety nets, the twin needs of creating more employment and more security can be
decoupled. The prevailing notions of social justice place too much emphasis on equality of outcomes for individuals, which can discourage effort and investment in human
capital and thereby reduce economic growth. On the other hand, the notion of social
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justice as equality of opportunity increases incentives for effort and is consistent with
the requirement of competition that is inherent in capitalist development.
Islamic thinkers can play a critical role in redefining these notions for their citizens
based on Islam and shari’a to keep them from appearing as alien values, imposed from
the outside. Islamic values are already compatible with private property, but they need
to be reinterpreted for modern economies that depend on competition and incentives
for effort and the accumulation of skills.
The experiment in Iran has failed in this respect. After the 1979 Islamic Revolution,
anti-capitalist sentiment grew and for an entire decade the country’s economy moved
in the direction of greater state control and a smaller role for markets. In the 1990s,
in the aftermath of the destructive war with Iraq, populist slogans were traded in for
reconstruction, and serious efforts were made to reverse the anti-capitalist trend so
as to provide a greater scope for the private sector. But the populist streak proved too
strong: indeed, it brought Ahmadinejad to power in 2005. Today, private employers
are still viewed with suspicion and wealth is often considered ill-gotten. The public
discourse on social justice has not moved beyond equality of outcomes: Iranian politi108 cians fight over who can redistribute more in favor of the poor. As they do this, the
education system – once blind to social class, offering children of all economic backgrounds roughly equal access to free higher education – has turned into a race in an
uneven playing field. Indeed, the children from richer families are aided with private
schools and an army of private tutors to win over the coveted slots in public universities. The Ahmadinejad government, instead of increasing equality of opportunity, is
busy finding new ways to redistribute income to the poor.
The case of Iran also illustrates the challenges presented by an abundance of oil
revenues (relevant for other rich countries in the region as well). The unemployment
of educated youth is exceptionally high in Iran: youth tend to spend long years attending schools that do not increase their likelihood of finding a job, and depend on
their parents for income late into their twenties. Oil income raises labor costs – what
economists call reservation wages – and reduces the competitive position of workers
in the oil-rich country. This problem has been exacerbated by increased competition
from low-cost producers in East Asia. It is particularly pronounced in Persian Gulf
countries: youth here suffer from high unemployment as workers are imported from
East and South Asia. Private employers in Kuwait, Saudi Arabia, and the United
Arab Emirates shun local labor because they find foreign workers cheaper and more
productive. Capitalism works well in these countries, but not for their own citizens. To
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increase the participation of young workers in the labor market, these countries must
use their vast wealth to increase the training of their workers so they can compete in
the global economy.
AN UNHAPPY EXPERIMENT. The experience of the Middle East with capitalism and globalization has been an unhappy one. For decades, authoritarian regimes
promised a path to modernization that would avoid the harsh edges of capitalism (high
competition and low job security). Leaders only partially delivered on this promise.
Their state capitalist systems did improve education and health, and kept poverty and
inequality moderately low – certainly by the standards of Latin America – but because
they used state employment as the principal incentive for education, they failed to inculcate the core values of a modern economy, in which individuals acquire skills that
are useful not to bureaucrats but to private employers. The Arab Spring has effectively
ended the relevance of this model, but without offering a clear alternative.
In the aftermath of transitions in the Arab world, Islamic parties are winning votes – if
not hearts and minds – by offering a new, untried path. The danger is that the masses
of poor who vote for these parties, instead of being offered a real alternative to the 109
system that has collapsed, find a populist alternative, based on the redistribution of
existing wealth rather than the generation of new wealth. Going down that road will
trap these societies in a zero-sum game that will leave them behind in the fast moving global economic competition and will relegate the region to the role of supplier of
natural resources for decades to come.
If they are to avoid that fate, the new generation of leaders must find a way to take
advantage of their mandate, earned years ago in the prisons of the old regimes and
now at the ballot box, to forge a new social contract – call it Islamic social democracy
– that reconciles the basic tenets of competitive markets with the values of Islam and
the culture and traditions of each country.
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