Arab States’ Rigid Economies Are a Ticking Time Bomb

Among all Arab civil society organizations, the Nobel Prize-winning Tunisian General Labour Union (UGTT) has arguably done the most to defend the ideals of democracy in the region. It was a key guarantor of Tunisia’s transition to democracy after 2010 and continues to stand up to authoritarian President Kais Saied, refusing to support the sham parliamentary elections he orchestrated last December and January.

What is less well understood is that the UGTT has contributed to the fiscal and economic crisis that enabled Saied’s authoritarian rise. It has defended the interests of relatively privileged insiders on the labor market—public sector employees—while doing little or nothing for Tunisia’s vast army of unemployed and informally employed outsiders who work in the private sector without formal contracts or social security. This has contributed to economic inequality, social frustration, and pervasive economic inefficiency.

Throughout the Arab world outside of the oil-rich Gulf, the state protects shrinking groups of insiders while exposing outsiders to the brute forces of the market, encouraging inequality.

The situation is typical of a general economic ailment throughout the Arab world outside of the oil-rich Gulf: static systems by which the state protects shrinking groups of insiders while exposing outsiders to the brute forces of the market, thereby encouraging inequality and undermining economic dynamism, productivity, and growth. Countries as diverse as Algeria, Egypt, Jordan, and Morocco share this lopsided approach to capitalism.

In all these cases, the state protects insiders not only on the labor market but also among businesses, which are broadly divided into crony firms with deep connections to the state on one hand and marginal, informal firms on the other. The latter receive little state support and, if anything, try to avoid the government’s heavy bureaucracy.

As I argue elsewhere, the Arab world’s economic development issue is not simply one of “too much state,” as many pro-market reformers argue, or state withdrawal, as leftist critics advocate, but instead of the state’s very uneven presence: overprotecting some while neglecting and marginalizing others. This uneven system is ensconced through vested interests that form key political constituencies: namely, state employees and crony networks in business.

Outsiders, by contrast, are much less well recognized as political constituency as they are socially marginal, busy with daily survival and badly organized. The static nature of Arab economies gives few incentives to firms or workers—whether insiders or outsiders—to upgrade productivity or skills, leading to stagnant economies.

To reach a more inclusive social contract and a new growth model, the region needs a form of egalitarian liberalization: a transformation of insider privileges into general social safety and support mechanisms that might be less generous but are more broadly available, safeguarding social inclusion as well as fair competition and economic dynamism.

For the time being, such fundamental change is not in sight. The region’s insider-outsider divides have deep historical roots in the ambitious, state-driven economic development programs of the post-World War II era. Especially in populist republics such as Algeria, Egypt, and Syria, these programs involved control over the private sector as well as larger state apparatuses and more extensive state employment than in any other region of the global south, a legacy that is difficult to change.

Most insider jobs in government allow at best a modest lifestyle, and in some cases public sector workers have experienced substantial declines in real incomes. Yet hourly wages remain higher than in the private sector (including private employees with formal contracts), which is unusual in comparison to other regions. In Latin America, for example, a more fluid labor market means there is no systematic public sector wage premium. Job security in the Arab public sector is very high and welfare benefits, especially pensions, are much better than in the private sector.

Politically driven insider employment can impose large efficiency costs in the public sector. Overemployment is particularly rampant in state-owned enterprises: In 2021, Tunisair owned 26 aircraft, of which only seven were operational, while employing 7,600 people—more than 1,000 per functioning plane. The UGTT has resisted all attempts to consolidate the payroll.

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Maintaining such insider constituencies is expensive. Tunisia has one of the world’s highest spending ratios for public salaries, reaching 15.1 percent of GDP in 2022. At the same time, fiscal constraints restrict new hiring, which means that young jobseekers have scant chances of getting a government job. Given weak job creation in the private sector, most young Arabs are either unemployed or stuck in precarious and badly paid informal jobs such as street vending or driving. Labor force surveys show unusually low mobility between insider and outsider status: The informally employed remain so for a very long time, while public sector insiders almost never leave their jobs.

High spending on insider benefits leaves few resources to support private labor market outsiders, who receive little or no social assistance. Spending on benefits not tied to formal employment is lower than in all other world regions. Non-contributory pensions, unemployment benefits, and cash grant systems are underdeveloped, leaving the weakest behind.

The frustration of outsiders has shaped Arab politics. In Tunisia in particular, outsiders have been prominent in social protests. Tunisian street vendor Mohamed Bouazizi, whose self-immolation triggered the Arab uprisings of 2010-11, was a quintessential outsider. Yet political feedback loops have kept the current system in place: Regimes are afraid of touching insider privileges given their long-standing reliance on the state-employed middle class as a core political constituency.

To the extent that political mobilization is possible, insiders are also better organized—most notably in Tunisia through the UGTT, but also in Egypt during its brief liberal window after the fall of then-President Hosni Mubarak in 2011, when newly emerging independent unions mostly represented state employees.

Even when military dictator Abdel Fattah al-Sisi took over Egypt in 2013, the one law his docile parliament refused to ratify contained civil service reform measures. Outsiders stage occasional demonstrations, but they seldom demand systemic changes to labor markets or welfare systems. They rather tend to ask for government jobs—demanding to be made insiders rather than overturning the system.

Meanwhile, thickets of protective regulation inherited from the post-war era of state-driven development facilitate corrupt networks between state and business elites. Licensing and inspection requirements, state-controlled access to land and credit, discretionary subsidies, and trade protection remain pervasive.

State elites use such tools to protect insiders while making it difficult for the vast army of unconnected firms to compete. Empirical research on Arab cronyism shows the staggering scale of insider privilege. In Egypt, “politically connected” companies under Mubarak accounted for only 11 percent of total employment but held 60 percent of total net profits among listed firms.

The 2010-11 uprisings were in no small measure directed at corrupt business barons, yet they have done little to remove crony networks. Egyptian steel tycoon Ahmed Ezz worked as a widely despised political fixer for Mubarak and was one of most high-profile arrests after Mubarak’s fall. Yet he has since left prison, and his companies, which benefit from cheap state-provided energy, are reporting bumper profits.

As in Arab labor markets, there is very low mobility among firms between insider and outsider status. Arab companies stay small and informal for longer than in other regions, while large firms go out of business less often than elsewhere. Even more than in the case of labor, insider companies are better organized and able to influence state decisions. When markets are formally liberalized, notably in the context of international trade agreements, insider firms often manage to lobby for new discriminatory rules in other areas of regulation to safeguard their privileges.

Sheltered insider firms have few incentives to become competitive, while outsiders have little opportunity to grow and innovate.

Sheltered insider firms have few incentives to become competitive, while outsiders have little opportunity to grow and innovate. The static insider-outsider divides in the Arab private sector contribute to low productivity, weak innovation, and poor export performance. One byproduct of this structural weakness is the scarcity of good, formal jobs in the private sector, which in turn reinforces the Arab middle classes’ reliance on and demand for state jobs.

Together with weak state education systems, this results in weak skill levels across Arab economies. This further reduces the chances of outsiders to find good jobs—and makes insiders cling to their privileges further, given their lack of competitiveness on a more open market.

In sum, the widespread narrative that neo-liberal, pro-market reforms have led to inequality, corruption, and economic stagnation across the Arab world is at best incomplete. While mismanaged and self-dealing liberalization measures have contributed to all these problems, the abiding, deep protection for select groups of insiders from the market is just as problematic and distortive.

Unless a new social contract is found, the inefficiency of the current system will make everyone worse off in the long run, including insiders the state can no longer afford to support. Egypt has travelled the furthest down this road towards general pauperization. Repeat rounds of currency devaluation have started to bring insiders in the public sector workforce down to the level of outsiders (while generally preserving the interests of crony businesses).

While Sisi’s regime has made attempts to create more inclusive social safety mechanisms, these have remained modest due to the regime’s fiscal constraints and its inability to address the major inefficiencies created by cronyism in the private sector.

What the region instead needs is an egalitarian liberalization, under which insiders give up some or all of their privileges while the state steps up its support for outsiders through more systematic investments in universal social security, entrepreneurship, and training.

Public sectors could be downsized through voluntary golden handshake policies, early pension packages, and assistance programs for finding private jobs—all coupled with state wage support for lower earners in the private sector to reduce wage inequality and combat poverty more effectively. Crony insiders in the private sector must be exposed to real competition, with state elites building a broader support base among the private sector at large.

Negotiating a new social contract along these lines will require political leadership and the willingness to recognize outsiders who tend not to mobilize against the state—by now a majority in all Arab countries—as a key political constituency. This is harder in the region’s authoritarian environment, with its limited or absent party competition and tight controls over civil society. By contrast, in Latin America, new welfare policies with a stronger focus on informal workers often emerged in the wake of democratization.

Short of a miraculous return to democracy in the Arab world, one can only hope that its authoritarian rulers understand how the current system gradually erodes their own support base: They are increasingly unable to maintain the old social contract with labor market insiders, a shrinking constituency.

It would be in rulers’ own long-term interests to start devoting more attention to outsiders who, while not organized as a lobby, are capable of spontaneous unrest that has critically contributed to past unrest and revolutions. Rulers would also do well to remember that citizens’ hatred of unproductive crony capitalist insiders was a key factor that brought people into the streets during the last wave of uprisings.