At the beginning of 2008, crude prices are at record highs, creating immense wealth for oil-exporting nations in the Middle East. Yet the Arab economies also face what economists call “a demographic bulge of a fast-growing labor force” — and the challenge of creating enough jobs for the population. This is happening at a time when the arrival of China and India is raising the competitive stakes for other emerging economies that want to make their mark on the global economic stage. How are the Arab economies dealing with these challenges? Howard Pack, a professor of business and public policy at Wharton, and Marcus Noland, a senior fellow at the Peterson Institute for International Economics, address these issues in a book titled, The Arab Economies in a Changing World. Knowledge at Wharton recently spoke with Pack about his book. An edited transcript of the conversation follows.

Knowledge at Wharton: Economists are predicting that oil could average $85 a barrel in 2008, and the OPEC countries seem to be going strong. Yet creating jobs for young people seems to be a challenge for the Arab economies. What explains this paradox?

Pack: The OPEC countries have large amounts of oil and relatively small populations. Dubai may have a native population of about 400,000 and it has immense oil wealth. On the other hand, countries like Egypt, which have very large populations, around 80 million, have very little oil wealth. Now, part of the wealth from the Gulf countries like Saudi Arabia, Kuwait and Dubai gets repatriated to Egypt because Egypt sends a lot of workers to the Gulf. On the other hand, given the size of Egypt’s population, that has a relatively limited impact on Egypt. The same thing is true of Algeria, Morocco and Tunisia. Algeria does have substantial natural resources, but these are diminishing. The populations [in these countries] continue to grow relatively rapidly, although the rates of growth have slowed down. Therefore, for the next 10 to 15 years, there’s a very large bulge in the group of people aged 15 to 25 who will be looking for jobs.

Knowledge at Wharton: Do you think the emergence of China and India will affect the Arab economies and their ability to integrate with the global market?

Pack: The big problem that China and India pose is of a following type: One way in which the Arab economies, at least the ones that have large populations, could deal with this population bulge is to have a significant amount of employment generated by potential exporting industries. They are just across the Mediterranean Sea, in many cases, from the European market. They all have trading agreements with the European market.

The trouble is that while that was a good model to try to pursue 25 to 30 years ago, whatever the Arab countries now try to do, they face these two extraordinary competitors — China in manufacturing and India in services — and that represents a very serious problem. To try this in 2007 is very different from what it was when we were trying to get on board the globalization train in 1977.

Knowledge at Wharton: Oil in the Middle East can’t last forever. What strategies are these countries adopting to deal with the time when the oil runs out? What do you think of those strategies?

Pack: The countries in the Middle East have learned a lot from their experience in the 1970s and early 1980s, when they again had a huge bulge in earnings from oil. And, in some way those resources were frittered away on wasteful projects, and to some extent — but much less than often thought — on corruption.

What these countries are doing now is quite interesting. Most of them are trying to accumulate foreign exchange reserves. Indeed, several of the countries now have what are called sovereign wealth funds. These are huge conglomerations of capital controlled by the government. And we know that recently Citibank was able to tap one of these sovereign wealth funds for almost $5 billion. They are also acquiring other forms of assets throughout the world. They are hoarding dollars or other foreign exchange reserves correctly, in anticipation of these reserves running down. That being said, some countries like Saudi Arabia have reserves that will last for a very, very long time. 

Knowledge at Wharton: Investing money overseas — such as your example of Abu Dhabi investing in Citigroup — will not necessarily lead to an increase in employment within the Arab countries themselves. Do you think that there is enough skilled labor in these economies to justify a labor intensive growth strategy?

Pack: That’s a good question, because partially what has to be done is to improve the quality of the labor force. In the book we note that the number of years of education has been going up significantly in the Arab countries including the oil countries, but also the non-oil countries like Syria, Jordan and the North African countries. On the other hand, the quality of this education is really open to question. Moreover, they do not have large numbers of people enrolled in critical areas such as computer science, engineering, and the basic sciences. So the possibility of taking in technology from the rest of the world and generating jobs for the lower skilled people is going to be limited by this absence of high-tier people. Then the question is: What do you do with lower skilled people? And in principle we know what should be done; we have seen precedents in East Asia — Korea and Taiwan — which had very similar problems in the 1960s and 1970s.

The trouble is that questions arise about the willingness of people to take some of those jobs. There was an extraordinary example recently in Jordan, which has a free trade agreement with the United States. This means they can export textiles, and especially clothing, to the United States. A number of foreign investors have come in and established factories and sometimes joint ventures with the Jordanians. It turns out that, quite shockingly, given the unemployment rate in Jordan, most of the workers that have been hired in these factories are non-Jordanian citizens. They are Bangladeshis, Pakistanis and to some extent Indians — but there are almost no Jordanians. Now, there is the question of why this unwillingness to work in factories occurs, but it is nonetheless a significant issue.

Knowledge at Wharton: As your book points out, the Middle East has seen relative political stability compared with places like Latin America and Sub-Saharan African. And yet, this has resulted in what you describe as “stultifying policy inertia.” What policy changes do the Middle Eastern economies need?

Pack: There are some notable features in the Middle Eastern economies. There is a need for growth that is usually called “import liberalization,” which involves reducing tariffs and reducing other obstacles to imports of foreign products. Then, there are a whole series of internal questions which come up and which have not been dealt with.

In the book, we have a very detailed example of the cost to potential Egyptian exporters because the country’s port system does not work well; the airlines do not work well; the road system is terrible, and a host of other things that have to be addressed directly. This is so the potential for exports, which in a country like Egypt in principle is large, can be realized. So, the policy changes required are manifold. Of course, they have to deal with things that can be done relatively easily — almost by the stroke of a pen — such as reducing tariffs. But then they have to become very good at reducing a whole set of other obstacles to successful businesses.

For example, it takes a very long time in Egypt for businesses to get permits to do a variety of things. It takes a very long time to get a telephone connection. And while it is fashionable to say that this is a result of being an Islamic country, as we point out in the book, it take ten times as long in Egypt as it does in another Islamic country — Tunisia. So Islam, by itself, does not provide an explanation.

Knowledge at Wharton: Are some countries doing things better than others, which might offer lessons to the rest of the region?

Pack: Dubai seems to have a lot of things going for it. The quality of the people in Dubai is really quite astounding. We had an Executive Education program in Philadelphia over the last year and a half for officials from Dubai, and they were spectacularly good and spectacularly well plugged into the international economy. I think that’s less true in other countries. Dubai cannot provide an easy template for the other countries because it has very specific circumstances in terms of oil revenues and other things per capita. Tunisia and Morocco have done okay.

None of the Middle Eastern countries have done spectacularly well, which is very interesting. In Latin America, Chile has done extremely well. Asia for a long time had Korea and Taiwan and then were joined by a host of other countries such as China and India, and now, interestingly, Vietnam. But there have been no champions of economic growth in the Middle East. This is disappointing, and therefore, there is not a sense of confidence that if they change policies they will succeed. There is no [one] country that has done spectacularly well. 

On the other hand, one has to notice that Morocco, Tunisia and Egypt have not done that badly. They look remarkably like Columbia, which has not had spectacular growth. Columbia doesn’t look like Korea and Taiwan, but it has done okay. At the current rates of per capita income growth — until this recent oil price spike which may or may not last — they were growing 2% to 2.5% per year per capita, which means that it will take roughly 30 years, a little bit more, for their incomes per capita to double. If you contrast that to countries where growth has been 5% to 6% per year and where it takes 12 years for income per capita to double, then you will see that they have not done well. 

Knowledge at Wharton: In fact, your book says that “The neural synapses that would link the latent productive possibilities of the Arab people with the goods and services demanded by the rest of the world appear to be weak or non-existent.” How can that problem be overcome?

Pack: That sentence and the “neural synapses” phrase have drawn a lot of attention. We gave several presentations in Washington at The Peterson Institute and people brought this question up very frequently.

Currently, the big issue for most of the developing countries is that they want to become part of the world trading system. A large part of this system is dominated by production and buyer networks. A production network might be thought of as Dell assigning individual products — such as keyboards, monitors and a motherboard — to a variety of its sites throughout the world and putting them all together on the UPS truck in the U.S. You also have buyer-led networks such as Wal-Mart, which orders a lot of products and knows a great deal about how and where these are produced.  These networks are now exceedingly important. It’s arguable that 60% to 80% of international trade is now accounted for by these buyer and seller networks.

The Arab economies could become part of these networks, but so far they simply have not. There is some weak evidence in North Africa that there are call centers being established. But it is very difficult to see how this is going to occur because it’s pretty late in the game. If you’re an American business based in Chicago, or a British business based in London, and you have to make a decision on outsourcing, would you go to China or Vietnam? Or would you go to Egypt or Tunisia or Morocco? I think that the decision has been clear. The Arab countries get very little, remarkably little foreign direct investment.

Knowledge at Wharton: Given what you have said, what might be your most pessimistic and optimistic scenarios for the Middle East over the next five years?

Pack: I think that one has to think through the political scenarios. The Middle East also includes Iran, and one simply doesn’t know what Iran will do. There are large numbers of people in the Sunni Arab world who are terrified of Iran, and this may deflect a lot of attention towards nuclear weapon development and away from dealing with economic policy. But the most optimistic scenario would be that the countries reform relatively rapidly, that their ports become efficient, and their roads become good. That being said, I still think that it’s going to be pretty difficult.

But if all of those things were to be put in place, I think that the countries would have a good chance of growing at a somewhat greater rate than they have been in the recent past. For countries in North Africa or in Jordan, this would mean growth of 3.5% to 4% per year, which would be unprecedented for a sustained period of time in these countries. That would be the optimistic scenario. In the Gulf, I think that those countries, assuming the oil price sticks, will do okay. Although they still face the question of what can be done for a lot of the younger people who still don’t have jobs there.

The most pessimistic scenario would be a stagnation model in which they grow very slowly, the way that they have done on and off in the post-World War II period. Between 1960 and 1980, they had reasonably good growth. For the most part in these countries 1980 to 2000 was pretty slow. Part of the collapse between 1985 and 2000 was due to the oil price decrease. Now most of the countries have better policy making in place. One should look carefully at Egypt, which has a lot of Wharton trained MBAs in the government. That being said, one could conceive of a scenario in which political extremism, the threat of Iran and the absence of a determined leadership lead to stagnation.