Middle East: When Peace Comes, Revival and Reconstruction Will FollowPublished: March 26, 2003 in Knowledge@Wharton
The assault on Iraq by the U.S. and its allies is curtailing economic activity throughout the Middle East as tourism and business travel plummet, consumer spending is put on hold and investment uncertainty deepens. As the war wears on, the extent of its impact will vary from country to country, depending on the nature of their economies and how heavily they rely on oil for revenue, according to wide-ranging interviews with Wharton faculty and alumni, as well as economists and business people in the United States and the Middle East.
In the short term, these experts say, the reconstruction that will take place in Iraq following military action will lead to billions of dollars in spending on infrastructure. In addition to providing large projects for multinational construction companies, the rebuilding of the country will create opportunities for smaller entrepreneurs. The entrepreneurs will try to turn a profit by serving the needs of the big firms and at the same time capitalize on a nascent consumer market emerging from years of dictatorship.
The Wharton faculty and other experts interviewed by Knowledge@Wharton for this article, prepared in collaboration with the Egyptian Young Bankers Association, say that the economy of Iraq, a country blessed with oil, abundant water, arable land and an educated populace, could benefit substantially in the future if a stable government is put in place in Baghdad. Indeed, the Middle East as a whole could become more attractive to foreign capital -- but only if the Israeli-Palestinian conflict is resolved and the region grows more stable and democratic, according to several executives in the region.
Over time, the war will have different effects on what could be considered the two distinct components of the Middle East: countries with complex economies but no oil to speak of, such as Israel and Turkey, and those that are petroleum powerhouses, such as Saudi Arabia. In the near term, though, some shocks to Middle East economies will be common and widespread: Oil producers will wonder where prices are headed and tourism-related businesses will fret about the disappearance of vacationers and executive travelers.
“The effects on the developed economies in the Middle East are not very different from the effects on the economy of the U.S.,” says Raphael (Raffi) Amit, professor of entrepreneurship at Wharton and a native of Israel. “Even before the beginning of this war, everything was on standby. Consumers were reluctant to spend money on durable goods like houses, cars and refrigerators. Unemployment has been high in the Middle East, and manufacturers have been very anxious. Companies have been very reluctant to make capital expenditures. Many of them have reduced their workforces, which further lowers consumer confidence.” Amit adds: “War stifles economic activity. It curtails investment, growth and innovation. Innovation has to be funded with capital, but during a war capital doesn’t see exit opportunities [if an investment goes bad].”
Tourism and business travel have suffered sharp declines, as airlines have cut services to the Middle East and as wary travelers have stayed home. Duby Pekelman is a professor at the Interdisciplinary Center (IDC), a university in Herzliya, Israel, and a member of the Wharton Fellows program. “Tourism has died,” he says flatly. “You hardly see any tourists throughout Israel and the whole Middle East.” Pekelman says the deleterious effects of the decline in air travel are not limited to tourism. Business relationships can suffer when managers are unable or unwilling to go abroad. “It’s difficult to do business when your customers and suppliers cannot come and visit you,” he laments.
In addition to teaching at IDC, Pekelman is chairman of Arkal Industries, a holding company for several firms that export plastic parts for the auto industry and water filtration systems. Several months ago, as tensions between the United States and Iraq grew, Pekelman decided to move some of Arkal’s production from Israel to Hungary, Germany, Portugal, Spain and China. Arkal also has increased its inventories to guard against potential supply shortages. As tensions have increased, so has Arkal’s cost of doing business. Certain raw materials that cost Arkal $600 a ton not long ago now cost $900 a ton.
Pekelman says his biggest fear is that the war will cause his customers to lose confidence in Arkal’s ability to deliver products in sufficient quantity or on time. In such a case, he says, “we’d have to move all production and even some development operations outside Israel. That would make it difficult to operate because we would lose some [employees] who would not like to move their residence outside Israel. This would be an unpleasant situation.”
“Business has slowed down and it’s much more difficult to raise capital,” says Isaac Devash, founder of Fantine Capital and the Israel International Fund in Tel Aviv. “People find it more difficult to make decisions and deploy capital in the Middle East at this time.” But opportunities have begun to emerge. “The shortage of capital has reached a point where a small amount of capital can allow you to buy a bigger component of a company. Independent thinkers will do very well if they have patience,” says Devash, who serves on Wharton’s advisory board for Europe, Africa and the Middle East.
Oil Prices in Play
Oil prices have declined since coalition forces moved into Iraq. But prices remain significantly higher than they have been during the 1990s and early 2000s, which has been a boon to Middle East oil producers. “In the short run, the war has been fairly good for oil-producing countries; oil prices have been driven up since autumn,” says David Ingram, director of international economics at Economy.com, a research firm near Philadelphia. “Over the medium term, say from now until the end of the year, oil prices will plunge fairly rapidly at the conclusion of the war if things go well. That’s bad for oil-producing countries. Over the long run, if you go beyond end of this year, one can assume they’d be lower than they are now.”
Hisham Ezz Al-Arab, chairman and managing director of Commercial International Bank in Cairo, says the war is harming Egypt’s economy in several ways -- the disappearance of tourists and reduced shipping through the Suez Canal stemming from a general slowdown in local and worldwide trade. For example, Al-Arab says his bank estimates that if the Iraq war ends within two months, the cost to Egypt’s tourism industry would be $1.5 billion to $2 billion.
Al-Arab also says it is important to take into account the ripple effects of a general decline in business. “We spoke to vegetable growers and they say orders from hotels have been coming down,” he says. That means “fewer trucks are needed to transport vegetables.”
Hussein Choucri, chairman and managing director of HC Securities, a Morgan Stanley affiliate in Cairo, says the war will actually help the economies of oil-producing countries to some degree, even if oil prices drop. For one thing, businesses in those countries benefit from the spending that accompanies the presence of coalition troops on their soil. What’s more, sectors other than oil comprise a small part of the economies of the Persian Gulf states. The gulf states “are not going to be really negatively impacted because their income doesn’t depend on trade, foreign investments and tourism.”
So far, Choucri has not seen any appreciable impact on his bank’s business, but he and others note that foreign direct investment and business activity in general was in decline throughout the Middle East before the war began. “Egypt in particular had experienced some slowdown before the war,” Choucri says. “We were running at a reduced level of activity and have not seen further reduction of our business as a result of the war. If somebody has in mind some new ideas or projects [that require foreign investment] nobody is going to do anything at this time. They’ll wait till things settle down.” Ingram of Ecomony.com agrees. Foreign direct investment in the Middle East “has been drying up -- not due to the war, just due to the sluggish world economy.”
The commitment made by President Bush to rebuild Iraq after the fighting ends will be a boon to companies in many parts of the world. The New York Times has reported that the reconstruction effort, the largest of its kind since the Marshall Plan in Europe following World War II, could cost $25 billion to $100 billion.
According to news accounts, so far U.S. companies have been the only firms permitted to submit bids to the U.S. government for reconstruction contracts. But this has become a contentious issue, and European companies strongly believe that they too should get an opportunity to participate in the reconstruction of Iraq. Reportedly Tony Blair, the British prime minister, plans to discuss this question with U.S. president George Bush at their Camp David meeting on March 26. If companies from other parts of the world are able to participate in Iraqi reconstruction, it might help stem some of the flak that the Bush administration has been facing on this issue. For example, the Associated Press reported on March 26 that a unit of Houston-based Halliburton won the contract for extinguishing oil well fires and repairing damages to the wells in Iraq. "Halliburton was led by now-Vice President Dick Cheney before he resigned in 2000 to join the Republican presidential ticket," AP reports.
Al-Arab, Choucri and others point out that the economic activity that will arise from reconstruction will also extend to companies and workers in the Middle East because the large American multinationals seeking contracts employ not just Americans but people worldwide. Moreover, they say, the rebuilding process will offer opportunities for other, smaller firms. “The reconstruction will require high technology and advanced technology, of which countries like Egypt, Turkey and Jordan have an abundance,” according to Choucri.
Sam Alameddine, an entrepreneur who lives in Dubai, United Arab Emirates, says he plans to start a couple of businesses in Baghdad as soon as the guns are silent. First, he says, he will refurbish an existing building and turn it into a hotel with up to 100 rooms. He also wants to establish a company that will offer broadband Internet access via satellite. He says both ventures will emphasize top-shelf service and cater to the contractors, consultants, engineers and others who will flock to Iraq for reconstruction.
“I was in Afghanistan after it was liberated and I noticed a keen shortage of office space, business centers and hotel rooms,” says Alameddine, who owns several businesses in Washington, D.C. “There’s no concept of customer service and salesmanship in Afghanistan and [other countries in the region].” This stems, he says, from a “combination of socialism, totalitarianism and lack of investment.” He adds: “There are no Internet service providers in Iraq, maybe two or three Internet cafes, but only for people in the Baath Party. So you can’t rely on the local phone infrastructure for creating an ISP.”
Alameddine is not the only entrepreneur eagerly awaiting a chance to move into Iraq. The Wall Street Journal reports that Kuwaiti business people -- selling everything from mobile-phone service to air conditioners -- see a once-in-a-lifetime chance to reach more than 20 million people in an emerging market.
The kind of political system that will emerge in postwar Iraq cannot be known, but the Bush administration has said that it is committed to the establishment of a representative government. Experts interviewed by Knowledge@Wharton say the creation of democratic institutions in Iraq -- and perhaps elsewhere in the Middle East, over the very long term -- may result in far-reaching economic benefits for Iraq and other countries in the troubled region.
“If you look at the evidence of what’s happened in other countries -- with freer people and less dictatorship – [those countries] do not become like the United States, but every place that [democracy] has been tried it seems to have worked spectacularly,” says Martin Anderson, a fellow at Stanford University’s Hoover Institution and former Reagan administration official. If Iraq “joins the modern world,” Anderson adds, it will bode well “for all kinds of things that are good.”
Al-Arab of Commercial International Bank notes that before Saddam Hussein took power, Iraq “was one of the most advanced countries in the Middle East. It has very educated people. They have not only oil but water and agriculture. They can feed the entire region, all over the Gulf, from the basket they have. If you have water and agriculture and educated people and oil, what else do you want?” Expatriate Iraqis, Al-Arab adds, have demonstrated their business acumen – the kind of entrepreneurial spirit that may help accelerate economic growth after the war. “The key thing they need in Iraq is a regime not supported by the American army but by the people themselves,” according to Al-Arab.
A stable Iraq could also succeed in attracting foreign direct investment, allowing it to shore up its oil-production facilities and become an even more formidable oil power. “The best-case scenario for the OPEC countries is the war ends and Iraq joins the OPEC cartel and adheres to quotas and prices and prices remain high,” says Ingram. “For the rest of the world, the best-case scenario is the war ends, firms begin to implement the capital-investment strategies that they postponed, and foreign direct investment and tourism starts to flow back into the region.” The worst-case for OPEC, Ingram continues, is that Iraq boosts its oil production significantly and prices plunge. “It would be hard for OPEC to keep prices in the $18- to $22- per-barrel range that it’s seeking if Iraq is pumping to its capacity.”
Road Map for the Middle East
Hundreds of miles from the battlefields of Iraq, however, is another deadly conflict that will play a major role in the future of the Middle East. Choucri, Al-Arab and Pekelman agree that true stability and the expansion of market economies in the region will never be more than temporary until a solution is devised to settle the conflict between Israelis and Palestinians.
“We need not only a stable government in Iraq, we need the ‘road map’ for the Middle East to be realized,” says Pekelman. “It seems President Bush and [British Prime Minister] Tony Blair are committed to the road map. This intervention is necessary. Otherwise, the two sides cannot create any reasonable, stable solution.” Adds Al-Arab: “Changing the regime in Iraq will be good, from Afghanistan to Morocco. But you have to sort out the Palestinian issue and then you will really have a stable system. Bush will go down in history if he could sort that out. He would [become] the hero of the Middle East.”
Devash of Fantine Capital says the presence of the American and British forces in Iraq is “just the beginning of the beginning; it’s not the end of the journey.” He says the new Iraqi leadership should emulate Kemal Attaturk, the founder of modern Turkey. “Attaturk created democracy in Turkey,” says Devash. “If you ask me, that’s the model. The model should be looking for the new Attaturk, not Bush forcing American values on Iraq.”