Civil unrest in Egypt and Tunisia has created uncertainty in the Middle East, demonstrating that even the region’s established economies and their security apparatuses can stall under pressure from the street. Even before these revolutions, global consulting firm Oliver Wyman found in its December poll of Gulf executives that such events are viewed as the biggest threats to companies.

In October, the firm compiled a study on energy security for the World Economic Forum on the Middle East and North Africa in Marrakech, Morocco, concluding that it is a key risk to stable growth in the region, and that economic and population growth are placing increased demands on resources. The risks, the study stated, potentially could halt growth and push some essential services to failure.

In an interview with Arabic Knowledge at Wharton, Oliver Wyman CEO John Drzik says regional governments and businesses need to have strategies that see linkages between these risks and provide inclusive solutions for them.

An edited transcript of the conversation follows.

Arabic Knowledge at Wharton: Considering the recent civil protests and violence in Egypt and Tunisia, ongoing fighting in Yemen, and concerns about Iran, instability remains an ever-present threat in the region. What can regional governments do to better prepare for such risks? Does your firm see a need for better risk management strategy in the region?

John Drzik: We [asked] what executives saw as the biggest threat to business conditions in their country. Macroeconomic shock headed the list (at 52%), which is not surprising given recent history. This business audience ranked regional military conflict (6%), internal tensions (3%), and terrorism (1%) as lesser threats on a relative basis. This doesn’t mean these risks are not important — they are. They just are not those that are top of mind to business executives in the region today.

Governments and businesses within the region would benefit from a more comprehensive risk management strategy. The Gulf Cooperation Council (GCC) — and indeed the Middle East and North Africa (MENA) more broadly — is a complex region that has a set of interrelated challenges that include resource scarcity, demographic change and economic growth, energy security, and insufficient infrastructure. Understanding that these risks are interlinked, and that any solutions need to consider stakeholders and interests broadly, is certainly one place for policymakers to start. Regional governments can certainly consider policy interventions that improve capital flows and investments in human capital and infrastructure. But governments will need to work with the private sector, not only to secure capital and knowledge, but to energize and encourage the social behaviors required to increase resource efficiency.

Arabic Knowledge at Wharton: A poll done last year by Oliver Wyman suggested rising optimism among CEOs in the Gulf. But how confident should investors be in the region? Do you feel governments here have addressed the concerns foreign investors have had during the last two years — particularly related to transparency and investor protection?

Drzik: When Oliver Wyman first did the survey with Zogby International in the autumn of 2009, transparency was a big issue, particularly in the United Arab Emirates (UAE). When we asked the question then, it was selected as the issue requiring the most immediate attention. And it’s interesting how events subsequently played out over the course of 2010, where there was both a call for more information and a release of a lot of information about the state of the economy, particularly in the UAE. We asked the question again this December, and the answer was different — there seems to be less focus on transparency now, with only 25% or so of UAE respondents placing it at the top of immediate issues. Taken across the region, only 13% see it as of immediate concern. Restrictive labor relations and limited access to financing rank much higher on the list of immediate concerns. Drilling down, key challenges in these two areas include excessive collateral requirements in the UAE, high interest rates in Saudi Arabia, and visa rules in both countries.

In thinking about the kind of systemic hurdles that confront investors, "inefficient government bureaucracy" and "problems with business regulations," ranked fairly low in this latest poll. Both ranked well behind labor regulations, which was the issue of greatest importance to our respondents in both the UAE and Saudi Arabia. Another interesting indicator on confidence in investment and in opening up business opportunity is the sense by those we polled that privatization should be a priority for their governments, with airlines, followed by telecoms, as the highest priorities.

Arabic Knowledge at Wharton: Wharton professors and Oliver Wyman analysts agree that energy security is a key risk the MENA region faces in economic growth. How well, though, are regional governments preparing for such resource challenges?

Drzik: The World Future Energy Summit held in Abu Dhabi in January highlighted both an increased concern generally, and in this region in particular, for the challenges posed by demands on energy resources. In October, Oliver Wyman contributed to a recent World Economic Forum report that focused on the key risks facing MENA countries — which included related water, infrastructure, and energy risks. The blessing of resources in some countries, this study found, can mask an increased dependence upon energy — indeed, the study found MENA countries 60% more energy intensive than OECD countries. What the report noted was that energy security, water scarcity, and underinvestment in infrastructure are mutually reinforcing chronic risks driven by the MENA region’s underlying growth trends. Given those interrelationships, more integrated energy and water management strategies within and between MENA countries are absolutely critical, given the limited resources that must be shared across sectors and geographic boundaries. Indeed, seen this way, there are tremendous opportunities in managing these risks at the regional level — to lower transaction costs for both businesses and governments, increase the value of investments, and catalyze deeper cooperation amongst stakeholders across countries and sectors. Dialogue across boundaries and between key stakeholders will help to create the kinds of regionally focused institutions that could fill the current void. This will help confront and surmount these risks and seize the opportunities that they also offer.

Arabic Knowledge at Wharton: A number of governments in the MENA region are allocating generous resources to promote alternative energy initiatives. Is this the best way to achieve these goals? Would these efforts be more effective if MENA countries adopted a joint approach?

Drzik: As I noted above with respect to energy security, because of the interrelated nature of the risks challenging the region, a cross-regional approach offers the means to both address the challenges and take advantage of the opportunities offered by these risks.

On the renewable energy side, Oliver Wyman’s continuing work in the energy and government sectors in the GCC has highlighted the promise of renewable energy as a means of addressing the MENA region’s energy security challenges. The goal is generating sustainable energy for domestic consumption and freeing up non-renewable resources for export. To date, many countries have set targets for renewable energy production; there are projects in various MENA countries, such as solar power projects in the United Arab Emirates, Morocco, Algeria, and Egypt, as well as wind power projects in Morocco, Jordan and Egypt. The newly created International Renewable Energy Agency (IRENA) is headquartered in Abu Dhabi, signifying the region’s growing focus on renewable energy.

But the challenges indicated in our poll — particularly those around labor and education — are echoed in the WEF research I mentioned earlier, most notably in a concern by the private sector about the level of human capital required to operate the technology-intensive mechanisms involved and about the need for the necessary infrastructure for exporting renewable energy to consumers in Europe and beyond.

Finally, another option on the agenda of decision-makers is nuclear energy. Notwithstanding the strong interconnections with geopolitical risks in the region, several MENA countries are considering new developments in this field.

As a recent Oliver Wyman white paper, "Building a Nuclear Culture in the Middle East" suggests, creating a national nuclear power program is far more complex than simply hiring a contracting firm and turning the key. Contracts for development are only part of the solution; people build and operate nuclear programs, and the greatest challenge each nation faces is in developing a successful "nuclear culture" within the workforce — again pointing back to some of the competitive challenges highlighted in our poll.

Arabic Knowledge at Wharton: We are beginning to see austerity measures adopted in the UAE — higher civil service fees, increased fines collection, budget freezes in education, and subsidies for gas and water being slowly removed. What does this tell you — is it a sign of greater efficiency or of financial strain?

Drzik: The recent global financial crisis has been the trigger and driver for change in governments across a number of regions and countries. In this respect, moves to drive performance into public sector organizations fits with the desire, post-crisis, to provide better service to citizens and enhance overall competitiveness. Indeed, many governments have started initiatives to link budgets to actual strategic plans rather than simply providing a lump sum to government officials to allocate funds. Understanding and setting the right incentives, like reductions of gas and water subsidies in favor of fees, will help to balance increasing supply and demand issues related to the ongoing demographic growth in the region — countries in the region can’t build and supply capacity fast enough to meet demand growth. So a viable lever is reducing subsidies in order to decrease consumption. But, of course, fee increases are only acceptable if they are directly linked to better services and performance.

Arabic Knowledge at Wharton: Canada and the UAE have engaged in a diplomatic tit-for-tat, and relations between the two have soured. Was there any way the dispute over landing rights could have been avoided? What lessons does this dispute provide for other countries and businesses with relations in the Middle East?

Drzik: A key lesson is that misunderstandings can often occur in the absence of data-driven insight. To return to the question of transparency raised earlier, while our research seems to indicate improvement in this area, data on business and government attitudes and beliefs is still, compared with other regions and countries, in short supply here in the GCC.

As our research suggests, and our conversations with clients confirm, the GCC region’s CEOs seem to have put the recent global economic crisis behind them and turned their attention back to regional and global competitiveness. Saudi Arabia and the UAE have undertaken focused initiatives on enhancing their competitiveness that look years into the future and set ambitious goals, and an increasing number of companies in the GCC can now rightly say they operate on a global stage. And the region has seen dramatic changes — in both the public and private sector — in the past few years. Countries like the UAE, Qatar, Saudi Arabia, and Kuwait have made and continue to make huge development strides, and they are fast becoming global centers of business that can’t be disregarded when looking at expansion opportunities. With this pace of growth, of course, ‘growing pains’ can occur.

Arabic Knowledge at Wharton: We have witnessed different initiatives arising around the need to promote entrepreneurship in the Middle East, but entrepreneurs tell us a lack of funding sources and cultural stigma against risk-taking remain obstacles for start-ups. What do you suggest can be done to foster more entrepreneurship in the Middle East?

Drzik: An environment that nurtures and encourages innovation and entrepreneurship will be more competitive, and GCC countries are making great strides in this direction. Our poll went directly to the issue of support for entrepreneurship. Overall, entrepreneurship and the necessary structures in place to foster it remains an issue, but both the private and public sector seem to be grappling with it.

Looking at the issue by region, Saudi executives feel business startups are easier to launch than do UAE executives. Across the region 57% of those that we asked responded that the banking industry was supportive, and 65% indicated that government regulations were supportive. When we asked whether it was easy for a small business owner to start a new company, nearly 60% of the Saudi executives responded that it was easy. Executives in the UAE were less positive: in fact, they were almost equally divided on the issue. Whereas 54% of our Saudi respondents said that it would be easy for an entrepreneur to obtain a loan, UAE executives found it more difficult in their country — 67% responded that an entrepreneur would find it difficult.

Arabic Knowledge at Wharton: A number of investors we have spoken to express skepticism about the validity of the Islamic finance industry, despite its growing acceptance. What must the Islamic finance industry undertake to ensure its growth, and what criticisms should be addressed to mollify its critics?

Drzik: We are optimistic about the opportunities that Islamic finance offers. Research that we did recently suggested that half of the 1.4 billion Muslims worldwide would opt for Islamic finance if given a competitive alternative to conventional services. But, generally speaking, despite this tremendous interest and striking growth rates, institutions, including the conventional players that have developed Islamic "windows" and Islamic incumbents and startups, need to continue to develop and to refine the necessary operational capabilities.

Our financial services partners in the region issued a detailed white paper that looked at wholesale banking and retail banking and identified a few key areas that could be addressed. According to this research and analysis, wholesale banks need to diversify their activities and to develop a more comprehensive service suite (including advanced treasury services, innovative asset management, balance sheet management, and securitization services) in order to address the needs of underserved market segments like Islamic financial institutions, corporations, and sovereign wealth funds, and private wealth clients. On the retail banking side, this study suggests, success in this market will require developing differentiated and segmented offerings, streamlining product development to boost innovation, and designing efficient processes. In addition, care must be taken in adapting marketing and the consumer proposition to Shariah imperatives.

Arabic Knowledge at Wharton: What has Oliver Wyman learned about the Middle East since establishing a presence in the region?

Drzik: The Middle East is a very dynamic region, and its influence on the rest of the world is growing. Our clients across the region are very sophisticated, and are looking for best-in-class expertise from their advisors. The consulting business in the Middle East has become increasingly competitive over the last couple years, and we need to bring top caliber people and our latest intellectual capital to be successful.

Clients in the region are also looking to see a long-term sense of commitment to the region from their consultants. In our case, we have made a number of concrete commitments over the past year to demonstrate that we see the region as one in which we intend to build a business for the long term. First, we opened offices this year in Riyadh and Abu Dhabi to complement our existing office in Dubai. Second, we’ve sponsored a regular research survey with Zogby International and an annual conference with the Financial Tmes to help bring insight to business and government leaders around the development of the region. Finally, we’ve invested in talent development initiatives in the region — such as topical workshops, and a "future leader" development program — to help address a key issue seen by our business and government clients.