Economies in the MENA region are striving to create a business environment that attracts foreign direct investment. The OECD’s Sarah Marion Dayan throws a spotlight on what governments can do to leverage investment and support development goals.
Governments in the Middle East and North Africa – and across the globe – expend considerable resources to support and attract investors, recognising the developmental benefits that businesses, and particularly foreign firms, can bring. Yet despite reforms designed to improve the investment climate, MENA governments either do not always see the benefits of foreign direct investment (FDI) or the benefits fall short of the expectations of both governments and citizens. Today, as MENA governments seek to respond to significant socio-economic challenges, exacerbated by the COVID-19 pandemic, it is more imperative than ever to succeed in harnessing investment for sustainable economic growth.
A new OECD publication looks at what is holding back investment in the MENA region, and what governments can do to leverage investment to support development goals. The potential advantages of FDI are well documented. In addition to bringing capital and jobs, international firms often import new technology and practices, supporting productivity growth, innovation, and skills development. OECD and other studies have found that FDI contributes positively to several Sustainable Development Goals (SDGs). But the benefits of FDI are not automatic. Realising the positive impact of foreign firms, and minimising potential adverse effects, depends in large part on government policy.
Challenges persist for investors despite notable reforms…
Over the past decade, MENA governments have advanced meaningful reforms to promote and facilitate FDI. Governments have revised investment-related laws, made it easier for foreign firms to enter the market and operate, strengthened government agencies charged with supporting investors, and adopted policies to direct investors to less developed regions. Some countries have already seen positive returns to these efforts. Tunisia and Morocco have attracted a growing share of FDI in sectors that support job creation and exports, including automobile and aerospace manufacturing, as well as tourism. Egypt is now the largest recipient of FDI in Africa, while Jordan and Algeria are attracting investors from more diverse locations.
Despite some positive developments, many MENA markets are struggling to compete with other emerging and developing economies for foreign firms. FDI to the region never fully recovered from the 2008 global financial crisis and Arab Spring movements of 2010-11; inflows to most MENA economies have stagnated over the past decade, with sharp declines since the start of the COVID-19 pandemic. While MENA economies are diverse, several common challenges have contributed to uneven investment in the region, and hindered inclusive economic growth more broadly. These include dominance of a few industries and firms, labour market incentives that favour public sector employment, poor regional integration (reducing market size) and governance challenges, as well as periods of severe political instability and conflict.
Investors also face more direct challenges. Rules and regulations on starting and operating a business are not always clear or transparent, and are often enforced in an overly discretionary or ad-hoc manner. This can cause confusion for investors, lead to unfair competition, and create opportunities for corruption. Co-ordination among government agencies involved in promoting and facilitating investment is often lacking, limiting their effectiveness at implementing policy. Some MENA economies rank poorly on many measures related to business integrity and responsible business conduct. Inadequate infrastructure connecting MENA cities to each other and to other markets means the cost of trade is often high.
…limiting the benefits foreign firms can bring
These challenges have affected the amount and type of investment flowing to the MENA region. Put simply, the sectors that attract the most FDI do not contribute the most to sustainable economic growth. In most MENA economies, FDI (and economic activity more broadly) has been concentrated in a few capital-intensive sectors, including real estate, construction, mining, and fuels. These sectors have not sufficiently advanced job creation or productivity, nor have they supported the growth of small and medium-sized enterprises (SMEs), or economic activity outside of coastal and urban regions. In eight economies in the region (Algeria, Egypt, Jordan, Lebanon, Libya, the Palestinian Authority, Morocco and Tunisia), including many non-oil exporters, almost half of all jobs created by greenfield FDI have been in manufacturing (Figure 1). But the sector receives only one-quarter of total FDI to these economies, compared to 40% in most ASEAN countries, according to a recent OECD report. With some exceptions, service sectors, which also generate more jobs per dollar invested than less labour-intensive industries, receive the least investment in many MENA countries.
Figure 1. Greenfield FDI is not concentrated in sectors with greatest job-creating potential
In addition to creating jobs, foreign firms can, and often do, contribute to other positive labour market outcomes. For example, OECD analysis on FDI impacts on sustainable development finds that foreign manufacturing firms tend to be more productive than domestic manufacturers. In line with this, they also tend to pay higher wages, on average, than domestic firms. The wage level is an important aspect of job quality. But in MENA economies, foreign firms have not always brought these benefits (Figure 2). In Morocco for example, foreign manufactures tend to be more productive than their domestic peers, but do not pay higher wages. In Tunisia and Jordan, foreign manufacturers have not pushed up productivity or wages.
Attracting investment in sectors that can create more and better quality jobs is priority for all MENA governments. Youth and overall unemployment – a key contributing factor to popular discontent – is higher today in many MENA countries than it was in 2010, prior to the Arab Spring social uprisings. Even before the COVID-19 crisis, almost one in three active youth were unemployed, the highest youth unemployment rate in the world, according to ILO estimates. Although the number of job losses linked to the pandemic is not yet clear, recent ERF research indicates that incomes have started to decline noticeably.
Figure 2. The benefits of FDI are not fully realised in MENA economies
Relationship between FDI and labour market outcomes (>0 = positive relationship)
Further work is needed to maximise the positive impact of investment
MENA governments will have to do more to attract FDI in more diversified sectors, and upgrade practices of new and existing investors to maximise the positive impact of investment. Middle East and North Africa Investment Policy Perspectives makes four overarching policy recommendations that can contribute to achieving this goal:
- MENA policy makers should expand efforts to ease investors’ entry, operations and growth. This includes making investment-related rules and regulations more clear, and implementation more consistent and predictable. Reducing scope for bureaucrats to interpret rules widely would help curb corruption and level the playing field among firms. To attract long-term investment in sectors with greater positive spillover effects, MENA governments have to enforce legal protections and procedures to make operations more predictable.
- All MENA governments could do more to promote private sector competition, to attract investors in job-creating and skill-enhancing sectors. Special treatment given to large or politically connected firms should be reduced, and potential distortions caused by state ownership assessed. Governments could consider reducing restrictions on foreign ownership of service sectors, which tend to be high in MENA countries. Promoting competition in backbone services, such as transport and distribution, would improve productivity in these sectors and the industries that rely on them.
- MENA policy makers should consider more targeted policies to direct investment into certain sectors or locations, and upgrade investor practices. Governments could replace broad-based tax holidays with more targeted incentives for firms to invest in employee training or research and development. Improving skills of employees and suppliers would make workers more productive and products more competitive on the global market, while putting upward pressure on wages. To help investors enter untapped locations and sectors, governments could implement targeted programmes to link multinational firms to local suppliers. MENA governments could also do more to promote responsible business conduct of firms to support higher job quality.
- Good investment policy depends on good governance. MENA governments should improve coordination between agencies involved in promoting and facilitating investment to ensure policies are well implemented. Governments could also do more to align investment policy with other policies that influence the investment climate, including trade and innovation, to make sure investment policy best supports wider national development goals.
References and links
OECD (2018), OECD Investment Policy Reviews: Southeast Asia
Kraft, Assaad, and Ali Marouani (2021), The impact of Covid-19 on labour markets: evidence from Morocco and Tunisia. Economic Research Forum Policy Portal
For more information visit: www.oecd.org/investment