90154 July 2014 – Number 127 X1` Over the Horizon: A New Levant Sibel Kulaksiz1 Introduction: According to a new World Bank report,2 economic complementarities between Egypt, Turkey, Jordan, Lebanon, Iraq, Syria, and the Palestinian Territories are significant, with substantial welfare gains expected from increased trade and investments and, ultimately, economic integration. With a population of 224 million, a land area of 2.4 million km2, a nominal GDP of 1.4 trillion dollars, and close to major markets and transportation corridors, these “New Levant” countries have significant economic weight and promise. There are opportunities from deeper regional integration to derive significant benefits from economic complementarities and greater competitiveness. very heavy delays at borders between Arab states. Economic and Social Challenges in the Sub- Non-tariff measures impact most product lines in Region: Most of the countries in the sub-region have trade, especially impact of technical barriers to trade common challenges, including: (i) limited are high. For example, Egypt’s technical barriers to diversification of production and exports, (ii) weak trade affect more than 50% of the product lines, regional and global links, and (iii) large youth ranging from 54.7% of the product line in the food unemployment. The region also suffers significantly industry to 99.1% in the base metal category. from high trade costs. The major issues are poor logistics performance and facilitation bottlenecks. Weak regulations are also important barriers to integration. The Global Innovation Report shows For example, Egypt ranks 57 in logistics that most countries score weakly in regulatory performance index out of 155 countries. Lebanon performance. The region also suffers from ranks 97. Jordan and Iraq rank even lower. In perceptions of corruption. According to addition, transit traffic has been especially affected Transparency International, Iraq ranks 169 (out of by absence of cross-border cooperation, resulting in 174 countries), Lebanon ranks 128, and Egypt ranks 118. All these factors affect competitiveness. In 2013, 1 The author works in the Macroeconomics and Fiscal Egypt ranked 107 (out of 144 countries) in global Management Global Practice (MFMGP) in the World Bank group. competitiveness index. Lebanon ranked 91 and This K&L Quick Note was cleared by Bernard Funck, Practice Jordan ranked 64. Manager, Poverty Reduction and Economic Management Department (MNSPR), Middle East and North Africa Region, The World Bank. Good and Services Trade in the Region: Egypt and Turkey are potential growth poles for the sub-region 2 World Bank. 2014. Over the Horizon: A New Levant. World Bank. with possible spillover effects. In the last decade, Washington D.C. Egypt experienced a promising rise of trade in has solid export performance in several chemical goods with Turkey and other regional partners. sectors. Pharmaceutical firms in Jordan are Despite this growth, Egypt and Turkey remain attempting to move up the value chain where they under-traders given their potential. Regional have a revealed comparative advantage. bilateral exports to both are also less than expected. Jordan, Lebanon, and Tunisia are under-exporting to Recent export performances reveal diversification both countries. Also, Egypt does not over-trade with towards new, higher value added sectors in all any regional partner yet Egypt provides a key Levant countries. Country-specific diversification connection to Arab markets, especially while conflict potentials complement each other. Turkey is the continues in Syria. Turkey provides a large potential most diversified country in manufacturing market for Arab exports. Egypt and Iraq are well industries. Egypt and Syria have the potential to placed to attract capital investments from Turkey benefit strongly from more trade and investment due to competitive labor costs. Gains from integration with Turkey in similar industries. In investments can be particularly high if domestic and particular, there are large potential gains from international firms cooperate in joint ventures. knowledge and technology spillovers through linking with integrated production chains in Turkey. As Turkey, Lebanon, and Jordan increase their However, diversification into high-productivity dynamic comparative advantage, labor-intensive products is a slow process. Mashreq exporters are industries can move to lower wage countries such as slower to diversify towards higher productivity Syria and Egypt. This had started in the textile and products than leading global exporters. The figure garments sector before the 2011 upheavals. compares the performance of selected MENA Conversely, higher wage countries can benefit from countries with East Asia and Turkey (See Figure 1). technology spillovers from Turkish investors. Turkey's FTA agreements are operational, and the Figure 1 elimination of visa requirement is still on. The EU EXPY For Selected MENA (Left) and East Asian has a Customs Union with Turkey, and is therefore Countries (Right) in US$, PPP an important partner affecting the overall picture. Arab countries have a trade agreement among themselves and deeper integration with Turkey and Europe means better integration into global and regional value chains. Besides prospects for Egypt and Turkey, there are significant economic complementarities and trade and investment opportunities for other Levant countries. Intra-group trade in the Levant increased seven-fold from US$4.2 billion in early 2000s to US$29.7 billion in 2010. This partly reflects better policies but there remains significant untapped potential. For example, exports of Mashreq countries to other Arab countries, including the Gulf, are much more significant than exports destined for Turkey. Manufacturing and its Potential: Currently, traditional sectors such as food, textiles, garments, footwear, and mineral goods are dominant in the The Services Sector: Services trade policies are sub-region. There is a direct competition for regional highly restrictive in the Levant. The sub-region and world markets shares in traditional export ranks among the world’s most restricted in services sectors among Lebanon, Turkey, Jordan, and Egypt. trade across all sectors and modes of supply. Egypt Egypt is experiencing export growth in stands out for the high level of restrictiveness of predominantly low technology industries. Jordan regulatory regimes. Lebanon has the highest level of July 2014 · Number 129 2 restrictiveness in cross-border supply. All Levant trade agreements. The six founding members of the countries have highly restrictive regulatory regimes European Economic Community (EEC) had an governing the mobility of service providers, and this average trade complementarity index of 53 at its affects movement of skilled professionals. onset; the Canada and U.S. free trade area was 64. EU’s Eastern enlargement (Bulgaria, Hungary, Services trade in the Levant is dominated by travel Poland, Czech Republic, and Slovak Republic) was and transport, but exports of communication, 61. Turkey, Egypt, Jordan, Lebanon, Syria, and Iraq financial, and insurance services also increased are not too far off with trade complementarity rapidly over the last decade. Egypt, Jordan, and indices of 40-50 on average. Turkey have comparative advantages in transport services. Lebanon has comparative advantages in Concrete Steps in Pushing the Integration Agenda : the financial sector and construction and computer Despite the current political situation, there are services exports. Jordan and Lebanon have large concrete results that can be achieved through sub- services sectors and Lebanese and Jordanian regional cooperation in specific areas. Governments financial institutions have the potential to grow have the opportunity to act now. The vision for the further—a great opportunity for economies with future of the region should go beyond day-to-day limited natural resource endowments. politics. Countries in the region should review policy weaknesses and put in place an effective FDI, the Sub-Region and the Critical Role of the implementation mechanism to improve national and GCC: FDI inflows are concentrated in real estate, cross-country infrastructure, business rules and construction, tourism, and oil sectors. The Gulf regulations. Cooperation Council countries were by far the most important investors into Arab countries. Total Although current regional trade agreements generated investments from the GCC between 2003 and 2010 some positive impacts, they were unable to remove represented 75% of total FDI inflows for Lebanon, obstacles. There is scope for additional regional 69% for Jordan, 61% for Syria, 59% for Egypt, and liberalization of trade policies. The Levant countries 46% for Iraq. GCC will remain as a potential source should take unilateral measures to remove barriers of capital to the entire Levant region (See Figure 2). to trade. This can promote domestic reforms and create positive spill-over effects especially for Figure 2 countries that are working towards WTO accession, FDI inflows 2003-2010 for example Iraq and Lebanon. There is an urgent need to establish and maintain trade routes with faster handling and processing of trade flows. Some projects have been identified to improve transport infrastructure. For example, constructing eastward connections from Iraq on Jordanian side, and hence linking the northern corridor to Basra, Baghdad and Kerkuk. Constructing a main north transport corridor between Aqaba and Mersin and constructing a highway to connect to the Gulf by linking it to UAE. There are also railway and maritime projects, such as connecting Lebanon’s Tripoli port to the rehabilitated Hedjaz railway and to Basra. More projects are in the offing. ICT, and broadband in particular, is a powerful enabler of trade development. It is estimated that a Trade Complementary and the Levant: Indeed, 10% increase in broadband penetration is associated trade complementarities among Levant countries are with an increase in exports by over 4%. Turkey is the high and roughly comparable to levels among leader in the region, with international countries that historically formed successful regional communications charges about 11 times cheaper July 2014 · Number 129 3 than Tunisia. A reform path similar to the one households’ real income will increase under all followed by Turkey in telecommunications is a scenarios. Total employment is fixed in the model, condition for trade development. To encourage but the rising real income indicates potential competition, Levant countries need to remove benefits. Especially, services trade liberalization will monopolistic structures that control prices. lead to greater increase in demand for skilled labor. In the energy sector, there is a clear need to expand Conclusion: There is a great potential to change the the capacity of electricity generation. For example, economic dynamics in the region through deeper new electricity projects have been identified for economic integration. There is already a good implementation between Egypt and Jordan; other platform to build on—much of which was created projects link Iraq to Jordan; Jordan to West Bank; by private sector leaders in the region. This is clearly Egypt to Gaza; and Iraq to Turkey. The region has an area in which governments, the private sector, the capacity to compete in the international markets and CSOs will all play a role. Few Europeans in the for gas. For example, Iraq has the potential to depths of the depression or the unimaginable develop as a major supplier of pipeline gas. Also, a horrors of World War II could have imagined the positive development is the discovery of offshore emergence of the EU. Yet, despite the current crisis, gas in the Eastern Mediterranean. There is also a it remains a resounding success. There is no reason clear need for additional pipeline networks for cross why the Levant cannot move forward as well and border flows. For example Kerkuk - Amman and possibly do so in a quicker fashion. Basra – Kerkuk - Turkey represent potential gas trade networks. In parallel, investments are needed for processing, storage and handling at terminal points. In addition to actions on infrastructure side, countries will need to reduce subsidies and other forms of policies that distort energy prices. Contact MNA K&L: Gerard A. Byam, Director, Strategy and Operations. MENA Region, The World Bank. In financial services, it is important to remove Preeti Ahuja, Manager, MNADE limitations for regional banks’ ability to operate in Regional Quick Notes Team: financial markets. Also, it is critical to put in place Omer Karasapan, and Mark Volk Tel #: (202) 473 8177 dispute settlement mechanisms. The MNA Quick Notes are intended to summarize lessons learned from MNA and other Bank Knowledge Expected Welfare Gains: Levant economic and Learning activities. The Notes do not necessarily integration is a positive sum game under scenarios reflect the views of the World Bank, its board or its of reducing the restrictiveness of non-tariff member countries. measures; lowering transport costs; liberalizing services trade; and removing tariffs on agricultural goods and processed food. A computable general equilibrium model shows that effects of potential reforms will be significant. For example, cumulative welfare gains are expected to be as high as US$12 billion for Egypt, and US$10 billion for Turkey as measured in income. Iraq will likely gain the most in relative terms as its welfare rises by almost 17%. Jordan will have a 6.5% increase in per capita income, and Lebanon will have 3.3% increase. This means that all countries significantly benefit from deeper integration. Services liberalization is estimated to contribute 70% to 95% of overall welfare gains. Nearly all cumulative gains are a result of deeper integration through services trade. It is important to note that July 2014 · Number 129 4