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POLICY RESEARCH WORKING PAPER            2921
Initial Conditions and Incentives
for Arab Economic Integration
Can the European Community's Success Be Emulated?
Bernard Hoekman
Patrick Messerlin
The World Bank
Development Research Group
Trade
October 2002



I POLICY RESEARCH WORKING PAPER 2921
Abstract
Hoekman and Messerlin compare the European                   major constituency in each Arab country that has an
Community's "trade fundamentals" prevailing in the           interest in improving the performance of services-the
1960s with those applying in Arab countries today. The       natural resource-based and manufacturing sectors. A key
fundamentals differ significantly-Arab countries trade       condition for such an approach to be feasible is that Arab
much less with each other than EC members did, and the       cooperation helps overcome political economy resistance
importance of such trade in GDP varies greatly. This        to national, unilateral action, or, generates direct gains
suggests that a viable Arab integration strategy must        from cooperation in specific policy areas. The EC
follow a path that differs from the preferential trade       experience suggests that a services-based integration
liberalization-led approach implemented by the               strategy will be complex and must be carefully designed
European Community. An alternative is to complement          and sequenced. Given the importance of services-related
long-standing attempts to liberalize merchandise trade       trade and logistics transactions costs, a first step might
with an effort that revolves around service sector reforms   focus on bringing such costs down through a concerted
and liberalization. This may prove to be an effective        joint effort.
mechanism to support reforms as, in principle, there is a
This paper-a product of Trade, Development Research Group-is part of a larger effort in the group to investigate the
economics of regional integration. Copies of the paper are available free from the World Bank, 1818 H Street NW,
Washington, DC 20433. Please contact Paulina Flewitt, room MC3-333, telephone 202-473-2724, fax 202-522-1159,
email address pflewitt@worldbank.org. Policy Research Working Papers are also posted on the Web at http://
econ.worldbank.org. The authors may be contacted at bhoekman@worldbank.org or patrick.messerlin@sciences-po.fr.
October 2002. (43 pages)
The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about
development issues. An objective of the series is to get the findings out quickly, even ifthe presentations are less than fully polished. The
papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this
paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the
countries they represent.
Produced by the Research Advisory Staff



Initial Conditions and Incentives for Arab Economic Integration:
Can the European Community's Success Be Emulated?*
Bernard Hoekman
World Bank and CEPR
Patrick Messerlin
Institut d'Etudes Politiques, Paris
Keywords: Middle East, trade agreements, economic integration, services liberalization
JEL classification: F13, F15, 053
* Versions of this paper were presented at the conference "Economic Integration Among
Arab States," Egyptian Center for Economic Studies, Cairo, October 21, 2001 and the 4
Mediterranean Development Forum, Amman, October 7-8, 2002. We thank Mustapha
Nabli, Mounir Abdel Nour, Ahmed Galal, Heba Handoussa, Denise Konan, Maurice
Schiff and participants in the meetings for helpful comments and Francis Ng for
assistance with the data. This paper draws in part on a study for the Council on Foreign
Relations that appeared as Hoekman and Messerlin (2002). Financial support by the
Council on Foreign Relations is gratefully acknowledged by Messerlin.






Introduction
Regional integration is a central element of the trade strategies that are being pursued by
many Arab countries All countries in the region have concluded numerous bilateral
agreements to reduce trade barriers on a preferential basis. Many members of the Arab
League are engaged in an effort to abolish tariffs on intra-Arab trade flows altogether.
Most Arab countries around the Mediterranean have also signed free trade agreements
with the European Community (EC). The latter aim at the elimination of tariffs on trade
in goods with the EC (with the exception of agriculture) and also embody elements of
'deeper' integration-provisions calling for cooperation in trade-related regulatory areas
and future negotiation to liberalize investment and services flows.
While preferential trade liberalization efforts between Arab countries have been
limited in scope, this is beginning to change with the implementation of the 1998 Arab
League Greater Arab Free Trade Area (GAFTA), which obliges signatories to gradually
eliminate tariffs by 2006 (Zarrouk, 2000). However, the GAFTA is a traditional
agreement that is limited to merchandise trade. In contrast to the EC treaty, the GAFTA
does not imply the creation of a common market for services, investment and other factor
flows. Nor does it involve the establishment of common institutions to address regulatory
issues.
This paper asks what can be learned from the European integration experience for
efforts to pursue Arab integration. We do not address the issue whether there is (or will
be) political support for greater economic integration-instead we investigate what the
incentives are for Arab countries to pursue alternative forms of regional economic
cooperation. The approach we take is to identify the initial conditions that prevailed in
the EC and to describe how European member states dealt with major political obstacles
to integration through the design of institutions. We then compare EC 'trade
fundamentals' to those that apply in the current Arab context. We conclude that the
fundamentals differ significantly, suggesting that Arab integration will have to follow a
path that goes beyond a purely merchandise trade liberalization-based approach.
One alternative path that is identified is a service-sector driven integration
strategy. Given the importance of improving service sector performance in many Arab
1



countries and the potential gains from regional cooperation in the regulatory domain, this
may be a more effective route towards greater integration, not just regionally-where
there is only limited potential and thus likely to be limited political support-but into the
world economy more generally. The EC experience suggests a services-based integration
strategy will be complex and should be carefully designed and sequenced. Intra-Arab
cooperation in this area could start by focusing on addressing high logistics and trade-
related transactions costs (trade facilitation), establishing focal points and benchmarks for
pro-competitive regulation of key 'backbone' service sectors such as transport,
distribution and communications, and a concerted effort to remove entry barriers and
government restrictions on competition more generally.
1.    Key Dimensions of the EC
The basic principle guiding the formation of modem Europe has been to use an economic
process for a fundamentally political goal: "an ever closer union of the peoples of
Europe" (Treaty of Rome, preamble, first paragraph). It is important to understand that
this goal was based on a number of historical and economic factors.' For one, the notion
of integration had a long history. For example, in the nineteenth century, Europe had
been integrated through force of arms by Napoleon, which led to a significant
convergence in legislation and administrative procedures. Also relevant-was how
numerous German states had combined through the mechanism of the Zollverein into a
federal Germany. However, more recent history played the primary role in the formation
of the EC, in particular the Second World War. The desire to prevent war was an
overriding objective of many of those who supported European integration in the 1950s.
There was a strong perception that there was a positive correlation between trade and
peace.2
Before the war European countries relied heavily on trade with each other. The
collapse of trade in the 1930-40s provided a strong incentive to remove the barriers that
had been built up. The challenge was to satisfy the political need to maintain critical
' What follows draws in part from Messerlin (2001). See Milward (1992) for a historical analysis of
European economic integration.
2 Mansfield (1994) has concluded that, controlling for other factors, there is a robust negative relationship
between the volume of trade between country pairs and the probability of a war between them.
2



national industries and the support of powerful interest groups while allowing for greater
gains from trade to be captured. As is well known, the inter-war years had been
characterized by large-scale intervention in trade and beggar thy neighbor competitive
devaluations. The objective of integrating Europe provided the foundation of a
mechanism to reopen European markets.
An important feature of the EC is the success it has had in managing the trade-off
between net economic costs and political benefits for members. Europeans eager to create
some kind of federal Europe were ready to adopt a series of policies that are more
interventionist and costly from an economic efficiency point of view than Europeans
"merely" interested in peaceful coexistence between European states. The search for
balance between economic and political aspects has played a major role in the
Community's history. Political objectives were critical in the development of the EC, in
the sense that costly decisions from an economic perspective were possible because of
associated political gains. A consequence of this is that perceptions that the political gains
from European integration are decreasing require a reduction in the economic costs of
European unification to maintain the balance. Political gains from integration are subject
to diminishing returns. The political idea of a perpetual peace between France and
Germany had a profound appeal to Europeans born before the 1960s. However, as of
2001, the idea of a Franco-German war is so remote that younger Europeans do not see
the need to pay the economic costs that previous generations of Europeans were ready to
pay. Such shifting balances have led to efforts by the EC to expand membership and
deepen integration, and help explain why external protection has fallen over time.
Institutions
The basic constituent elements of the EC are well known. A major objective of the Treaty
of Rome, which established the European Economic Community, was the realization of the
four freedoms: free internal movement of goods, services, labor and capital, including the
right of establishment. Thus, the EC aims to establish a common market with a common
external commercial policy. The Community is unique in that it goes beyond inter-
governmental cooperation. This is reflected, inter alia, in the fact that EC law has direct
effect and that there are supra-national institutions-an executive (the European
3



Commission), a political oversight body (the European Council); a judiciary-the
European Court of Justice (ECJ), and a (directly elected) European Parliament. Of these the
Commission and the ECJ have been the most important in the pursuit of political and
economic integration.
The supranational institutions of the EC have played a major role in the process
of integration. The Commission has been the driver and guardian of the integration
objective. It has the power to propose directives and regulations, which, if approved by
the Council, and increasingly the Parliament, become EC law. As these laws have direct
effect, they supersede national legislation in the area concerned. The Commission is a
bureaucracy, staffed by nationals of the EC who are formally independent of their
governments. The Council provides national level political oversight, comprising of the
relevant Ministers of member states, or Heads of State, depending on the subject matter
under consideration. The Council must approve all Commission proposals, working
either on the basis of unanimity or weighted voting, again depending on the topic. Over
time, an increasing number of issues have become subject to voting.
The Commission administers the common policies of the EC, including trade
and agriculture-the two most important areas.3 It also enforces the various treaties that
have been concluded or amended over time. Of great importance here is enforcement of
rules on 'fair' competition-disciplines on state aids (subsidies) and restrictive business
practices by firms that have the effect of impeding trade (and the realization of an
integrated internal market). The Commission has an interest in both expanding its
ambit-through promulgation of new rules in the pursuit of integration-and in enforcing
the negotiated rules of the game. The Commission, an independent European
bureaucracy with its own financing-partly obtained from the revenues generated by the
common external tariff-has been a defender of the European integration objective in
times when member states have been less than enthusiastic (Winters, 1997). The
Commission played a major role, for example, in forming a coalition with the private
sector in the 1980s to re-vitalize integration through the proposal of the Single Market
3 The Treaty of Rome grants the Community (not the Commission, but a complex mixture of the Council of
Ministers and the Commission) the exclusive competence in trade policy. However, the way the Treaty
defines the scope of this common and exclusive competence is rather clumsy. Article 133 (113 in the initial
4



Program ('EC-1992'). This proved to be a powerful instrument to move further towards
achieve the objective of economic integration by introducing the principle of mutual
recognition and 'competition in rules' and taking a series of concrete measures to
enhance competition on services markets. This resulted in a boom in FDI inflows and
cross-border mergers and acquisitions, and induced the accession of a number of
countries that concluded that the costs of being outside the EC had become greater than
the benefits.
The Commission plays a major role in administering various mechanisms that
redistribute income and resources across groups in the EC. Any trade liberalization will
give rise to losers, who depending on their political power, may need to be compensated.
Indeed, if powerful, such compensation is a precondition for liberalization to occur,
unless there are other groups in society whose gains are sufficient to induce them to
mobilize against those who benefit from status quo trade restrictions. The compensation
required to make trade reform politically feasible can take the form of an exception to
trade liberalization, long transition periods, transfers from the budget (subsidies), or issue
linkage. All of these mechanisms were used in the EC. The common policies on trade and
agriculture were designed carefully to maintain relatively higher rates of protection for
'sensitive' industries, complemented by transfers (subsidies) to disadvantaged regions
and soft lending by the European Investment Bank for infrastructure and related types of
projects.
The second major player in the integration venture has been the ECJ, which over
time developed a huge case law interpreting the validity (legality) of national policies. As
the ultimate arbiter, the ECJ's decisions are final and binding on the member states. The
ECJ played a key role in the design of the Single Market Program by identifying the
significant scope that existed for the principle of mutual recognition to overcome national,
non-trade policies that impeded cross-border competition (see below). More generally, it
has ensured objective and consistent application and interpretation of EC law.
Treaty of Rome) only provides a non-exhaustive list of trade policy instruments. As a result, determining
what is and what is not covered required decades of rulings by the ECJ.
5



Trade and Trade Policy
The first milestone in the realization of the common market was the creation of a customs
union, that is, the adoption of a common external tariff (CET) and the implementation of
internal trade liberalization. To a very large extent trade and trade policy constituted the
glue that held the EC together.
Trade: In the mid-1950s, each of the six founding EC Member states exported
more than 25% of their total exports to the rest of the Community and all of them
together represented more than 18% of intra-EC trade (except Italy with only 1 1%).
Thus, all the founding members had both a substantial stake in intra-European
liberalization of trade, and enough 'power' to play a role (have a voice) in the process of
the creation of the EC. Germany, the largest member country, exported almost 30% of its
total exports to the rest of the EC, accounting for one third of total intra-EC trade. This
'initial condition' is of great importance in understanding the success of the EC-
members not only had great political interest in cementing a binding peace, but also had
great economic interest in revitalizing and further expanding intra-European trade. Note
that the trade involved merchandise. Trade in services, labor and capital was quite
limited, in contrast to other parts of the world.
Trade policy: Agreeing to a CET is a major source difficulty for many customs
unions. The more unbalanced are initial tariffs across prospective members, the harder
the task, unless high protection countries are seeking to use the customs union as an
instrument to liberalize trade. Agreeing on a CET and applying it has been among the
most difficult aspects of implementing customs unions-as illustrated by the GCC, as
well as many other attempts to form a customs union (World Bank, 2001). Sustaining the
CET can be equally if not more difficult. Any common tariff will imply adjustment
pressure as industries relocate. Industry interests will diverge across countries. Thus, in
the nineteenth century the American South objected strenuously to the high protective
tariffs sought by US 'infant' industries, which were mostly located in the North. The
tariffs raised production costs in the South and implied a transfer of resources to the
North, exacerbating the tensions that led to the US civil war. Similar tensions associated
with industrial agglomeration and implicit transfers helped cause the demise of the East
African Common Market (World Bank, 2001).
6



The initial conditions confronting EC members regarding the formation of the
CET were relatively favorable. The EC created its common tariff from four initial tariff
schedules (as Belgium, the Netherlands and Luxembourg were already a single customs
territory, the Benelux, with a common tariff schedule). Two territories (Germany and
Benelux) had rather low tariffs, and two (France and Italy) relatively high tariffs-an
ideal circumstance for using the simplest possible harmonization rule: the unweighted
average of the four tariff schedules. This greatly facilitated agreement on the level of the
external tariff, limiting disputes between EC member states to those tariff lines where
duty rates were different enough to make everybody unsatisfied by the outcome of the
unweighted average method. There were a non-negligible number of such cases-about
20 percent of all tariff lines (Messerlin, 2001). The GATT helped resolve many of these
conflicts by lowering tariffs across the board through multilateral negotiating rounds-
making the results of the averaging method more palatable to the more open Member
states, while offering compensation to more protectionist members through better access
to global export markets.
As discussed below, liberalization of internal trade was accompanied by managed
trade in key sectors such as coal, steel and agriculture, as well as the implementation of a
common external trade policy. The latter played a major role in the EC, and to some
extent became a substitute for foreign policy. The absence of other means for the EC to
take international action-there being no common foreign policy-induced it to carve out
zones of political influence through the intensive use of discriminatory trade agreements.
These agreements have had almost no economic impact on the EC. Rather, their role has
been to strengthen the hegemony of certain EC member states or to establish this. The
primary example of this over the past 40 years, is the role EC trade policy played in
supporting the 'territorial expansion' of the EC, which grew from the 6 founding
members in 1957 to 9 (1973), 10 (1981), 12 (1986), and 15 (1995) member states
(leaving aside the direct enlargement to eastern Germany in 1990, which had been
prepared for since the Community's birth, and was confirmed by special trade
arrangements between the former German Democratic Republic and the EC starting in
the 1960s).
7



Common Sectoral Policies
European integration has been driven in part by two sectoral 'engines': agriculture and
coal/steel. In both areas the EC has common policies. In both cases, the focus of the
common policy is on managing production and trade. In the case of coal and steel, the
1951 Treaty of Paris establishing the European Coal and Steel Community (ECSC), the
precursor of the EC, reflected a strong tradition of collusion between steel firms backed
by national governments.4 In the early 1950s intra-EC free trade in steel was impossible
given German comparative advantages-substituting prevailing private barriers for
public management and control thus made a lot of political sense. But the price paid was
to inhibit and distort competition in this industry for the next five decades. Perhaps
equally, if not more important, it also provided a demonstration effect for other sectors,
which were given an incentive to push for and support industrial policies that benefited
them.
Although the coal and steel industries were of fundamental importance in the
design and launch of the European integration effort-not least because they were seen as
a major potential source of conflict between France and Germany-agriculture was
equally important. In all 6 founding members, farmers in the early 1950s constituted a
significant share of the labor force and GDP. Managed trade in this sector was seen as a
necessary condition to pursue integration more broadly. The Common Agricultural
Policy (CAP) aimed to: (1) increase farm productivity, (2) ensure a fair standard of living
for the agricultural community, (3) stabilize markets, and (4) assure the availability of
supplies at reasonable prices. Until the early 1 990s, the CAP was essentially based on
using one instrument (price supports) to reach all these objectives, causing steadily
increasing distortions and costs. The political rationale for the CAP-as in the case of
coal and steel-was that free trade, even in principle, was neither feasible nor desirable.
As far as the two major players were concerned, Germany wanted access to the large
4 The ECSC provisions were influenced by the "Entente Internationale de I'Acier" (International Steel
Cartel), set up in 1926 by steel makers from Belgium, France, Germany, Saarland, and Luxembourg. The
"Entente" reflected the prevailing view that cartels were a good mechanism to ensure market stability in the
context of intra-European trade liberalization. The ECSC pricing rules (broadly similar to the US Pittsburgh
basing point system abandoned in 1924 following an antitrust order) were a major element of 'managed
trade' in this sector.
8



French market, which was highly protected-as were almost all EC markets- but could
be bought offby the promise of higher prices for agricultural produce (Winters, 1997).
Over time, virtually all agricultural goods became subject to common market
organizations (CMOs). Until the' 1992 CAP reform, the CMOs relied essentially on a set
of multiple guaranteed prices determined on an annual (or half-yearly) basis by the
Council of Ministers. Because these guaranteed prices were unrelated to world prices, the
CAP required import barriers to insulate the product markets concerned from the world
market. These barriers took the form of variable import levies. Adjusted on a daily basis,
these raised import prices to the level prevailing in the EC. In the 1970s, export subsidies
began to be necessary to dump surpluses into world markets. In an effort to limit excess
supply caused by high guaranteed prices. As of the 1980s the CAP imposed such a
budgetary burden on the Community that quantitative limits on production were imposed,
voluntary set-aside programs were adopted, and subsidies were granted to low-income
consumers to increase demand.
The CAP was a great success in terms of expanding output and increasing self-
sufficiency in food. Indeed, it was too successful-imposing serious budgetary strains
and, more importantly for the rest of the world, imposing major costs on non-European
food producers and generating decades of multilateral tension. Although the raison d'etre
for the CAP has largely disappeared, agricultural reform remains highly contentious in
the EC. Support for agricultural and related rural policies to support farmers remains
strong, although increasing driven by environmental and public health concerns-which
ironically are due in part to the production-increasing incentives of the CAP.
Domestic regulation
It has been argued that Europe could not make much progress toward trade liberalization
until "it was discovered ... that further progress depended on'... some policy of 'positive'
integration ... because the removal of discriminatory policies threatened to undermine just
as many entrenched interests as [policy integration] would have done." (Milward 1984, p.
421). The rhetoric of EC policy'makers and their advisors suggested that 'deeper'
integration-extending to domestic regulatory regimes and economic policies-was
necessary to attain intra-EC free trade. Policy makers such as Jelle Zijlstra, the Dutch"
9



Minister of Economic Affairs, were not alone in arguing in the early 1950s that credible
tariff removal required "common policies on taxes, wages, prices and employment
policy" (Milward, 1992, pp. 188ff). Many felt that policy harmonization was required to
equalize costs, and that without it a customs union would not be feasible, because
countries would impose new forms of protectionist policies. Thus, the Belgian coal
mining industry argued in the late 1940s that a common market could only be accepted if
German wage and social security costs were raised to Belgian levels.5 French officials
persistently demanded policy harmonization in the social area-equal pay for both sexes,
a uniform length of the working week-as a precondition for trade liberalization, given
that French standards were higher than in other countries.
Underlying these concerns was generally a fear by interest groups of an erosion of
rents, or a worry that domestic policies may be used to re-impose protection. Abstracting
from the common policies for coal/steel and agriculture-where managed trade and
production was seen as desirable and necessary-in a number of policy areas the EC
established disciplines on the ability of governments to use domestic policy instnrments
as a substitute for trade policy. Disciplines on enterprise behavior that impedes the
realization of the common market and on government assistance-subsidies-were
enforced by the Commission with varying degrees of intensity, but had an important
effect on ensuring that the 'conditions of competition' became more equitable over time.
A noteworthy feature of the EC has been actions towards 'deeper' integration
through harmonization of national policies dealing with regulatory objectives. This
focused on efforts to limit the market segmenting effects of national regulations
pertaining to health and safety. Progress toward harmonization was very slow, in part
because adoption of a Community-wide norm required unanimity. It took 14 years for
agreement to be reached on the composition of fruit jams; 11 for a directive on mineral
water (Vogel, 1995). Over 1962-79 only nine directives on foodstuffs were adopted.
In 1979, the ECJ threw out a German ban on the sale of a French product (Cassis
de Dijon) used to prepare an aperitif (kir) because it could not be justified on the basis of
5 In the discussion of proposals for a European customs union in the early 1 950s, virtually every question
that came to be addressed in the Maastricht treaty was discussed: a common European currency, monetary
policy, whether there should be freedom of labor, mutual recognition of professional qualifications, a
10



public safety or health. This established the principle that goods legally introduced into
circulation in one member state could not be barred from entering and being sold in
another. This principle was later incorporated into the 1987 Single European Act and the
1992 Maastricht Treaty on European Union. The "new" approach differentiates between
standards that have health and safety (public interest) dimensions from those that did not.
For the latter it made harmnonization redundant by requiring governments to accept
foreign regulations as equivalent to their own. For the former a process of determining
common minimum standards ("essential requirements") was agreed to. Progress towards
development of these standards was made easier by a decision to accept qualified
majority voting on issues affecting the functioning and completion of the single market,
and defining standardization as a Single Market Programme issue.
In sum, integration in the EC was driven very much by the engine of trade in
goods-all members had strong incentives to see intra-EC trade liberalized. Trade in
services and factors of production-labor, capital-played only a minor role. The EC's
success was based in part on an almost perfect balance of economic power. It was
'financed' by three large countries (France, Germany and Italy) of almost equal size in
terms of population and income, and two smaller countries-but large and skilled enough
to play the key role of mediators (Belgium and the Netherlands). These countries had
almost perfectly symmetrical and large stakes in the EC endeavor. The EC founding
countries traded more than 30 percent of their total external trade with the other
members. This mutual trade dependence and relative symmetry allowed the EC to use
trade liberalization as a vehicle for integration-there was no need to rely significantly on
integration of services or labor markets to achieve the members' goals.
This balance was maintained in the enlargement process-the initial balances
were never seriously put into question. Britain was as powerful as France or Germany,
and Spain was comparable to Italy. Other new members were similar in size to the
smaller founding countries. A retrospective sense of the 'luck' that accompanied the birth
and development of the EC during its first fifty years is best provided by the sudden, but
short-lived, hesitations in Europe that accompanied German reunification. Britain and
common company law, a free capital market, or common workplace and products safety standards
(Milward, 1992, p. 191).



France immediately showed old instinctive reactions of fear, while other member states
also demonstrated concerns. These reactions suggest that the EC would probably not
have been founded if there had been a unified Germany.
Integration also had an overriding political objective that was strongly supported
by all members-preventing another war in Europe. The EC is the child of three terrible
wars (1870, 1914 and 1939) that were responsible for millions of deaths in the six EC
founding countries. It was born in a world divided into two political and economic
regimes (market-driven democracies vs. central-planned dictatorships). During its first 30
years, it grew under the constant pressure of the Cold War.
What follows asks to what extent the economic factors that prevailed in the EC
apply to the Arab context, focusing in particular on the initial trade 'dependence'
conditions. As the motor of European integration was to a very large extent the
liberalization of intra-regional trade in non-agricultural merchandise (agriculture being
the subject of managed trade and EC-wide policies), an obvious question is whether such
trade could also be the basis of Arab economic integration.
2.    Merchandise Trade Fundamentals in Arab Countries
Countries in the region can be divided fairly naturally into three groups: relatively natural
resource-poor countries (less than one third of exports comprise natural resources), oil
exporters (more than two thirds of exports consist of natural resources-mostly fuels);
and an intermediate group where exports of fuels and ores constitute between one and
two-thirds of total exports). For completeness and purposes of comparison we report data
for other 'regional' countries-Cyprus, Israel, Turkey and Iran-as well as for Arab
states.
Smal product markets - nationally and regionally
The economic size of the Arab region is limited. Arab countries that are members of the
Greater Arab Free Trade Area (GAFTA)-noted with an asterisk in Table 1-represent a
little less than Spain's GDP. Only one Arab country (Egypt) has more than 60 million
inhabitants. One implication of the 'smallness' of many of the countries in the region is
that the costs to trade and investment due to differences in national laws or regulations
12



are higher than for the EC. (Four EC Member states have a population of more than 60
million, and only two Member states out of fifteen have a population of less than 5
million.) The limited market size of the Arab countries is a crucial factor why all efforts
to achieve regional economic integration since the 1 950s have failed-even if one leaves
aside the fact that they were conceived behind high protection with respect to the rest of
the world.
There is another powerful economic force working against integration: Arab
countries are relatively similar to each other%and compete more with each other for the
same export markets. Most Arab countries in the sample are either oil-rich or rely heavily
on oil exports. As the fundamental motive for trade is to take advantage of differences in
endowments (comparative advantage) between trading partners, this situation suggests
limited prospects for large benefits from regional economic integration. Offsetting this is
the fact that Arab countries exhibit a wide range of GDP per capita, from less than
US$500 (Yemen) to US$17,000 (UAE and Qatar). Such large income differences
generate incentives to trade by inducing product differentiation in order to respond to
different incomes and related tastes. But these differences appear too wide for the small
markets involved to be a powerful force for significantly greater intra-regional trade. That
leaves the possibility of production sharing or processing-type of trade, where labor,
energy or water-intensive parts of the production process is undertaken in countries
where such factors are in relative abundance. This type of trade has become important in.
Central Europe, North America, and East Asia. However, a pre-condition for this to
materialize is a substantial increase in the efficiency of services (reduction in transaction
costs)-discussed further below.
In sum, the data suggest that: (i) the region is fragmented into relatively small
economies, and, taken together is relatively small in economic size; (ii) many have
similar production structures, which limits their incentives to trade; and (iii) the wide
income differences in the region are unlikely to overcome the resulting trade resistance.
Product concentration and differentiation
As natural resources dominate exports of a majority of countries, we have focused so far
on "inter-industry" trade. This is based on specialization in production, with countries
13'



producing different products using different factor intensities. Such trade may be
associated with a concentrated export structure if the country's comparative advantage in
a limited range of products is very strong. Inter-industry trade is complemented by "intra-
industry" trade, involving the exchange of different varieties of similar "products," or the
exchange of goods that form part of a production chain (importing components and
exporting the processed goods). In most high-income and newly industrializing countries,
intra-industry trade accounts for a large and growing share of total trade.
The scope for intra-industry trade is more limited for fuels than for consumer
electronics, but exists even within the oil sector broadly defined. There are many varieties
of fuels, and numerous possibilities to produce differentiated oil-based industrial
products, such as chemicals. The potential for specialization and intra-industry trade is
augmented by the fact that oil and chemical markets are oligopolistic enough to induce
the few large firms operating in such markets to follow a policy of profit maximization
through market segmentation and product differentiation. More generally, intra-industry
trade is driven by economies of scale that make it profitable for enterprises to specialize
in similar but differentiated goods, and for countries to exchange these.
Various measures of the structure and composition of trade are reported in Table
2. Two indicators of product concentration in trade are reported: the number of distinct
product categories exported, measured at the 3-digit level of the Standard International
Trade Classification (SITC),6/ and the "Herfindhal-Hirschmann index" (HHI).7/ As
expected, oil-rich countries have concentration indices that are much higher than those of
natural resource poor countries-reflecting the concentration in oil (ores) and oil-derived
exports imposed by their very strong comparative advantages in fuels (ores). However,
this generalization requires some qualification. The UAE and Saudi Arabia have
relatively diverse exports, reflecting entrepot activity as well as processing and light
manufacturing activities in the UAE, and the chemical sector in Saudi Arabia. Note also
6/ The SITC is a UN statistical classification for international trade. There are 239 different SITC items at
the 3-digit level. The SITC measure of concentration is defined as the ratio between the number of 3-digit
items for which exports exceed US$100,000 and the total number of 3-digit items (there are 239 such
items). For small countries an additional criterion of at least a 0.3 percent share in total exports is used.
7/ The HHI is defined as the sum of the squares of the market share of each export item in total exports. The
lower the HHI are, the less concentrated exports are. The HHIs are calculated at the 3-digit SITC level.
14



that the number of product categories exported increased substantially in some oil
exporters, e.g., in Qatar. The shares of intermediate or resource poor Arab countries are
below those of Asian comparator economies, suggesting a narrower industrial base.
In a number of countries, especially Egypt, Morocco and Tunisia there has been a
significant diversification of the export base as measured by the SITC indicator. Indeed,
on average, the last two decades have seen trade in the region become less concentrated.
The HHI index suggests that this trend is more general than the SITC measure-
concentration appears to have been falling pretty much across the board. In the case of
oil-rich countries this reflects the oil price decline that occurred during this period, which
made the production of fuels less profitable compared to the production of oil-derivatives
or other goods. But for a number of countries, especially resource poor or less endowed
with oil, it reflects the pursuit of domestic reforms. Egypt registered a particularly large
increase in diversification, rising from 33 to 68 percent on the SITC diversification
measure, while the HHI fell from 0.58 to 0.28. Similarly large reductions in the HHI
occurred in Morocco and Tunisia.
Table 2 also presents data on the magnitude of intra-industry trade.8 The higher
the intra-industry trade (IIT) index, the more the trade of a country involves the exchange
of different varieties of a similar type of product. IIT of Arab countries is far below the
ratios registered by Asian comparators, which have IIT indices in the 0.60 range. Among
Arab countries, Tunisia has the highest intensity of IIT (30 percent), followed by
Morocco and the UAE. The magnitude of IIT has been growing rapidly in a number of
other countries, however, especially Egypt and Jordan. Oil-rich countries exhibit very
low IIT indices, due to their comparative advantage in a limited number of products. The
UAE is an exception, reflecting the entrepot trading activity of this economy.
Finally, Table 2 presents data on the share of parts and components in total
manufactured exports and imports. This indicator provides information on the relative
importance of 'assembly' activity in total trade. A high share of components in imports
combined with a low share of components in exports is observed in all Arab countries,
except Oman. This compares with much higher ratios and more balanced trade for
15



dynamic exporters in East Asia (Table 2). For countries with relatively high GDP per
capita (interpreted as a proxy for relatively high-wages), a combination of high import
share of components and low export shares suggests a high level of assembly activities
for domestic or neighboring markets, and hence a relatively high degree of effective
protection against imports of final (assembled) products. Such situations are often the
source of large rents for firms (wholesalers or retailers) that are able to import for local
assembly. This may also prevail in countries with lower GDP per capita levels, but a low
share of components in exports could also mean that these countries are used as assembly
centers for re-exports of assembled goods. However, data on outward processing trade
collected by the EC suggests this is not the case.
To summarize: (i) most Arab countries tend to have relatively concentrated
exports, although this has been changing rapidly for some nations (Egypt, Morocco,
Tunisia); (ii) there are low levels of intra-industry trade; and (iii) a high ratio of imports
to exports of components. This suggests important assembly activities directed at
domestic markets that are likely to require high protection against imports.
Political economy implications of intra-Arab trade patterns
The geographical pattern of exports of Arab countries mirrors what has been said about
export structure by product-to a large extent, it is the "corollary" in the geographical
context of the economic forces at work in the production, demand, and trade patterns.
The share of exports going to other Arab countries ranges from 0.9 (Kuwait) to 13.1
percent (Oman) for oil-rich countries, mirroring the production concentration of these
countries (reflecting their comparative advantages in the world markets), and the fact that
oil is consumed everywhere in the world (Table 3). For the largest oil producer/exporter
(Saudi Arabia), the share is only 7.6 percent. The "hard-core" set of countries that tend to
trade substantially with other Arab countries (around 20 percent or more of total exports)
is limited to Jordan, Lebanon and Syria (some 34, 45 and 18 percent of total exports,
The index is defined as IIT = I - [YXFj I Xijk - Mijk 1/(Xijk + Mijk)], where Xijk represents the exports of
products from industry i from country j to country k and Mijk represents the imports of products from industry i
by country j from country k. In this study industries are defuned at the three digit level of the SITC.
16



respectively). With the exception of Oman, tor all other Arab countries, regional exports
account for less than 10 percent of total exports.9
An important policy question concerning Arab economic integration is whether
these levels of intra-regional trade are 'too low' because of barriers to trade. An often
used index of the intensity of regional trade is helpful in determining whether the value of
trade between two countries is above or below what would be expected on the basis of their
importance in world trade. Identification of bilateral combinations where trade is below
expected levels can also help to identify the existence of major barriers to trade. Table 4
reports data on the intensity of trade.'0 Values below (above) unity indicate that trade
between two countries is lower (higher) than expected. The data suggest that intra-Arab
trade flows are not consistently lower than what should be expected. The only countries
that trade less with other Arab countries than 'expected' are Algeria and Kuwait. The share
of Egypt's exports to the region is about three times larger than what would be expected.
Trade intensity indices for Jordan and Lebanon are the highest, followed by Syria. Overall,
the intensity index for all regional intra-trade is more'than double the 'expected' level.
A criticism of the intensity indices is that they do not control for factors such as
GDP and trade costs as determinants of trade flows.-A commonly used technique to
incorporate such variables is the gravity model. " I Gravity model regressions on non-oil
trade for the period 1970-98 suggest that in the 1970s, being located in the Middle East
and North Africa region had no effect on bilateral trade volumes (Chang, 2000). In 1980,
Arab countries' trade is actually less than predicted by the model. In 1990 and 1998 this
pattern reversed, with intra Arab exports and imports becoming larger -than predicted by
the model. Research by Al-Atrash and Yousef (2000) concludes that while intra-regional
9 There is some uncertainty on the direction of trade given weak reporting by several countries.
'° The "trade intensity" index is defined as the share of one country's exports going to a partner divided by
the share of world exports going to the partner. That is, TlIj = [xfj/Xi,] + [xwy/X,t] where xij and x, are the
value of i's exports and world exports to j, Xi, is i's total exports and XWt are total world exports. An index of
more (less) than unity indicates a bilateral trade flow that is larger (smaller) than would be expected given the
partner country's importance in world trade.
'The gravity model explains bilateral trade between country (i) and country (j). Normally, the amount of
trade is directly proportional to size (income, population, land area, etc.) and inversely proportional to the
distance between trading partners i and j. It is expressed by the following equation:
= A y/'Pl   2yJprj2 D, where T is the amount of trade between two trading countries, Y is the GDP
of the country, P is the population, and D is the distance between the trading partners. Often additional
variables such as existence of a common border or language are also included-as explanatory variables.
17



trade in the Maghreb and among the Gulf Cooperation Council states is less than
predicted, this is not true for the Mashreq countries. Thus, the available evidence is
somewhat ambiguous on the question whether intra-regional trade flows are lower than
what would be expected given levels of GDP, population and geography. Simple shares
and trade intensity indices suggest intra-regional trade is not that low and has been
expanding; the gravity regressions suggest that trade is less than what would be expected.
However, there has been a noticeable change in the last 10 years, with trade now being
larger than what the standard gravity model would predict. (See the Appendix for a brief
discussion of trends in bilateral trade over the last 30 years).
Two questions that are particularly relevant for the prospects of trade-led Arab
economic integration initiatives deserve attention. First, to what extent do Arab countries
that export a lot to the rest of the region (relative to their total exports) also account for a
major share of intra-Arab exports? Second, how important are exports to other Arab
nations in GDP terms for individual Arab countries? The first question captures the
balance between the incentives of each country to go to a hypothetical regional Arab
economic integration conference, and its capacity to influence the outcome of such a
conference. The second question provides a very rough sense of the importance of intra-
Arab trade for the national economy of each prospective member. It can be seen as a
crude indicator of the strength of domestic political support for a regional Arab trade
option. Despite appearances, trade policy is fundamentally a domestic policy-that is, a
set of domestic bargains between conflicting domestic interests. This perspective
suggests it is important to ask if there is a sufficiently large domestic coalition in favor of
regional trade within key Arab countries. The importance of this question is amplified
when it is recognized that a country has altematiyes to regional trade. Many Arab
countries are already pursuing discriminatory agreements with one (or more) large
industrial country(ies). A significant number of countries have signed Euro-
Mediterranean Partnership Agreements with the EC. And, of course, many are members
of the WTO and have the option of pursuing multilateral liberalization.
The Arab countries that have substantial exports to other Arab nations (more than
$1 billion)-Oman, Saudi Arabia and the UAE-are all oil exporters. These three
countries account for almost 60 percent of total intra-Arab trade. As already mentioned,
18



with the exception of Oman, in none of these cases do intra-regional exports account for
more than 10 percent of the country's total exports (Table 5). In the case of Oman and
UAE, these exports are equivalent to 7-8 percent of GDP and go beyond oil and oil
derivatives, suggesting there may be significant political support for Arab economic
integration in these countries. However, it should be recognized that these are not large
countries in the regional context and therefore will have only have a limited capacity to
push such an initiative forward. Countries with a high share of their total exports going to
the Arab region-such as Jordan, Lebanon and Syria-represent only a small share of
total intra-Arab trade (3, 2, and 5 percent, respectively), implying that their potential
influence in a regional trade process is also likely to be small.
If we look at the ratio between exports to Arab countries and GDP, in addition to
Oman and the UAE, there are three countries where the share is above 5 percent:
Bahrain, Jordan, and Syria. This is not insignificant and suggests that these countries
have an interest in the pursuit of Arab economic integration. In the case of Saudi Arabia
the figure is 3.3 percent; for Tunisia 2.7 percent and for the other countries, Arab trade is
less than 2 percent of GDP.
These numbers suggest that the situation is significantly different from that
prevailing at the creation of the EC. In the mid-1950s, all prospective EC Member states
exported more than 25 percent of their total exports to the rest of the Community. Intra-
Arab trade shares are much lower for almost all Arab countries. Moreover, EC trade
amounted to more than 3 percent in the domestic GDP of all the future EC Member states
(5 percent for Germany), with Italy being the only exception at 2.8 percent. While the
Arab trade/GDP ratios for many countries are similar, an important difference is that the
variance is much higher-for a number of countries, including Egypt-which would have
to be an important member of any integration initiative-the ratio is quite low. Thus, the
balance between alternative trade agreements is tilted away from Arab integration.
To summarize: the available data suggest that: (i) intra-Arab trade is nkot less than
what would be expected given fundamentals, especially for non-Maghreb countries; (ii)
economies that sell a large share of their exports to the region (the potential 'hard-core'
supporters of Arab economic integration) account for small shares of total intra-Arab
trade; (iii) conversely, for countries accounting for a large share in total intra-Arab trade,
19



such trade accounts for only a small share of their total exports; and (iv) there is a large
variance in the magnitude of intra-Arab trade relative to domestic GDP for Arab
countries. All this suggests that the political economy of Arab integration based on
preferential merchandise trade liberalization is not propitious.
3. Towards a Services-based Integration Strategy?
What are possible alternatives? An obvious candidate is to focus on other markets.
Options include factor markets-labor, investment-and services. Labor movement and
associated remittances accompanied by relatively large (official) capital flows-mostly
transfers from oil-rich countries were important in the region during the 1970-85 period.
Page and Van Gelder (2002) argue that such flows go a long way towards explaining the
relatively good performance of the Arab region in reducing absolute poverty and the
lower extent of income inequality that prevails in many Arab countries. These flows
diminished very substantially in the 1990s following the decline in oil prices and the
repercussions of the Gulf war. While a resumption of official transfers is unlikely to re-
emerge, there is substantial scope for expanding the mobility of labor. This will be
closely associated with an expansion in trade in services, as many of the persons who
have incentives to move will be service providers.
Reforms in service-sector policies to reduce domestic production and trade costs
are needed in their own right. They may also have a high payoff in facilitating further
liberalization of trade of goods by enhancing the ability of firms to compete on world
markets. Services-related costs are high in many Arab countries. As far as trade is
concerned, logistics-related costs are often high due to government policies and
regulations that result in limited competition. Public monopolies in ports and port
services, combined with poor infrastructure for loading and storing goods, made the costs
for discharging a container two to three times higher in Alexandria than in other
Mediterranean ports. Port service charges in Arab countries can reach up to t0 percent of
the value of imported intermediate components (Cassing et al., 2000). Monopoly
shipping and domestic policies favoring national carriers result in low-quality, low-
frequency, and high-cost services. Similar observations can be made for air
transportation, telecommunications and utilities. Policies restricting trade in land
20



transport services, such as prohibitiofis on driveis originating in certain countries,
arbitrary changes in documentary requirements, surcharges and discriminatory taxes, and
prohibitions on obtaining cargo in the country of destination to take back to the country
of origin, impose severe costs on intra-Arab trade (Zarrouk, 2000, 2002).
More generally, inefficient services place a substantial burden on manufacturing
and agricultural sectors. Service inputs-ranging from financial intermediation and
insurance to the design and marketing of products and access to high quality low cost
telecommunications-are a major determinant of the competitiveness of firms: Because
services are often not tradable, service sector liberalization involves a mix of deregulation
(the dismantlement of barriers to entry-investment-and promotion of competition) and
re-regulation (the establishment of an improved legal environment, strengthening
specialized and independent regulatory agencies). The limited tradability of services
implies that FDI is an important avenue through which to acquire access to best practices
and new services. Given that many service activities are subject to investment restrictions
(e.g., nationality requirements, restrictions on movement of personnel, limits on foreign
equity shareholding), service sector reform is closely tied to privatization and removal of
licensing and related entry and operating restrictions.
Arab countries have tended to approach service reform in a piecemeal fashion.
Privatization has been slower than in other parts of the world; barriers to entry often
remain forbidding, both for domestic and foreign investors; and there are few
independent regulatory agencies to ensure markets are contestable. Privatization proceeds
generated in the Arab region constituted only 3 percent of the worldwide total in the
1990s. While the trend is upward-rising from some $22 million in the early 1990s to $2
billion in 1995 to more than $6 billion in the secpnd half of the 1990s-the role of the
state remains much higher than in other regions (ERF, 2001). Private sector participation
in infrastructure is very limited. Between 1984 and 1997, projects in the region added up
to only $9 billion, compared to a worldwide total of $650 billion, for a share of just 1.4
percent. 12 Given the inefficient operation and management of state-owned and controlled
12 Examples of recent initiatives include water supply and wastewater treatment (Oman), power (Egypt,
Morocco, Tunisia, and several GCC countries), transport (a port terminal in Yemen and a container
terminal in Oman; toll roads in Jordan, Lebanon, Morocco and Tunisia; port services in Morocco and
Tunisia), and telecommunications (the GCC countries, Jordan, Lebanon, and Morocco). See ERF (2001).
21



utilities, there is an urgent need to move to a sector-wide approach that includes a
combination of competition, incentive regulation, and private ownership (ERF, 2001).
Because services often cannot be traded, increasing access to domestic service
markets is likely to require the entry of foreign competitors through FDI. This will have
two effects: a reduction in what Konan and Maskus (2002) call the cartel effect-the
markup of price over marginal cost that incumbents are able to charge due to restricted
entry; and an attenuation of what they call the cost inefficiency effect-the fact that in an
environment with limited competition marginal costs of incumbents are likely to be
higher than if entry were allowed. Pro-competitive reforms can then have major impacts
on economic performance as many services are critical inputs into production. Moreover,
in sharp contrast to what happens with merchandise liberalization, services entry (FDI or
domestic) generates demand for domestic labor. Foreign banks, retailers, or
telecommunications operators all need local labor. Thus, while the deregulation of entry
inevitably will result in the restructuring of domestic industry, services reform has less
far-reaching implications for sectoral turnover and aggregate sectoral employment than
the abolition of trade barriers for merchandise. The simulation analysis undertaken by
Konan (2002) suggests that reforms in services are less demanding in terms of labor
adjustment than merchandise liberalization.
Services reforms can have a large indirect payoff as well-by generating political
support for-and thus facilitating-merchandise trade liberalization. Trade barriers are
still high in the region, not only because of tariffs but also due to a variety of nontariff
measures that raise trade costs (Zarrouk, 2002). As a result there remains substantial anti-
export bias in many Arab countries (Galal and Fawzy, 2002). Traditional
(nondiscriminatory) trade liberalization therefore remains a priority. One reason progress
in this area has been slow is that liberalization will invariably result in
contraction/adjustment of domestic industries that benefit from protection, while
industries in which the country has a comparative advantage will expand. Many of the
latter initially are likely to be small and dispersed, whereas the former are likely to be
concentrated. Thus the well-known political problem of building support for trade
liberalization-those that stand to lose often will have a substantially stronger political
voice as they have more information and more of an incentive to organize. Frequently it
22



will not be known beforehand which sectors and activities will become growth areas-
hence an additional lag between those who will lose and those who will gain from
liberalization. This makes the early transition process politically difficult and can impede
liberalization altogether.
Political constraints to trade liberalization may be overcome if reforms target the
service sector. Such reforms can lower trade-related transport, logistics and transaction
costs, and reduce the cost and increase the variety of key inputs such as finance,
telecommunications, marketing, distribution and similar services. Pro-competitive
reforms that facilitate entry by new firms will also generate employment opportunities for
skilled and unskilled workers who currently are employed by government or import-
competing private manufacturing, or who are unemployed. Indeed, a political
precondition for public sector downsizing is that such alternative employment
opportunities emerge. Fears of employment loss need to be addressed ex ante through
the establishment of safety nets and transitional adjustment assistance, but what matters
most is that employment opportunities are created elsewhere in the (regional) economy
following reform. A major benefit of a concerted strategy towards service sector reform
is that this will in itself generate greater demand for labor by the private sector-both in
services and goods-producing industries (Markusen, Rutherford and Tarr, 2002).
A central issue is the rationale for pursuing services trade and investment
liberalization in a regional context. Much of what is needed could be pursued through
unilateral action. Indeed, in other work we have argued that in general the need for
reciprocal exchange of policy commitments should be much less necessary in the area of
services than it is for merchandise trade liberalization (Hoekman and Messerlin, 2000).
This is supported by recent experience in many parts of the world, especially Latin
America and Eastern Europe, where great progress has been made since the late 1 980s to
privatize and increase competition in the service sector. A feature of many of these
efforts has been that reforms were pursued as part of macroeconomic stabilization or
transition programs-situations that have not arisen in the Arab context.
One possible explanation for the limited progress in addressing services-related
trade costs (trade facilitation, transport) and expanding competition and private
participation in 'backbone' infrastructure services in Arab countries is that there are
23



political economy factors that impede pro-competitive, unilateral reforms.13 Another is
simply a lack of information and understanding of the potential gains. Related to this
could be uncertainty regarding the design of complementary regulation and
development/strength of implementing institutions that are needed to ensure competition
prevails, universal service obligations are met, etc. Understanding what inhibits unilateral
reform is a critical question. Whether and how an Arab integration-based effort to
liberalize services can help to overcome the national political constraints to domestic
reform depends on which of these potential factors are relevant.
One clear case for concerted action (regional cooperation) in the services area is if
there are regulatory economies of scale or scope. But such cooperation can also help deal
with the factors just mentioned. In the case of uncertainty, concerted action in the context
of an Arab economic integration initiative could facilitate services reforms by creating
focal points, mobilizing the needed high-level attention and engagement by senior
decision makers, political leaders, and civil society. In the case of political economy
based resistance to reform-more on this below-it could be a mechanism for
governments to make credible commitments to a reform path. Only if there is a credible
commitment will manufacturing and other interest groups have the incentive to invest
resources and political capital in supporting implementation of services reforms and
resisting backsliding. Regional cooperation can provide a mechanism to "lock-in" a
reform path through pre-commitment to specific targets or outcomes.
What type of political economy constraints may impede national (unilateral)
reform in services in Arab countries? One possible constraint is related to the large role
of the State in many Arab economies. Greater participation by the private sector will
require privatization and abolition of entry restrictions for new firms. Government
policies and procedures are also the cause of high transactions costs at the border (red
tape). Thus, a major factor determining the relevance of any integration strategy will be
to what extent it will be used by governments to pre-commit to actions aimed at reducing
the role of the State. This implies the focus must be on government services as well as
'backbone' infrastructure, both hard and soft. Two interest groups play a major role in
13 It is illustrative that only Algeria, Kuwait, Tunisia, and Turkey currently have (weak) competition laws,
while efforts to adopt such legislation in Egypt, Jordan, and Morocco have proved contentious.
24



this connection-government employees in general, and more specifically, those
responsible for enforcement of regulatory policies and procedures at the border
(Customs) and for specific service industries (sectoral regulators).
Cross-country experience suggests the latter group can be a serious constraint to
the adoption of more pro-competitive policies. Sectoral ministries or regulators that
oversee service industries often will be more concerned with supporting domestic
incumbents and maintaining the status quo, having little incentive to actively encourage
new entry and greater competition-be it from domestic or foreign suppliers. The
bureaucratic incentives confronting sectoral regulators generally will imply that little
weight is put on the economy-wide dimensions of policies.
The resulting entry barriers often create significant rents for incumbents, who
have a strong interest in blocking attempts to increase the contestability of "their"
markets. It is important to ensure that potential entrants are free to enter service markets,
and that policies do not discriminate against foreign as opposed to domestic entrants.
Entry barriers in many service activities tend to be justified by invoking market failure
rationales that revolve around information asymmetries, fears of excessive entry, the need
for universal service, etc. While there is often a valid rationale for intervention
(regulation), this does not generally require the creation of legal entry barriers.
Regional cooperation might also assist in the removal of national entry barriers by
providing a focal point for reform and mechanisms to monitor progress. In addition, there
are also potential regulatory economies that can arise. One element of such cooperation
could include establishment of regional regulatory agencies to oversee network services
(telecommunications, electricity, railways and other critical "backbone" activities) and
move to "de-balkanize" Arab markets for such services. Regional regulatory agencies
could facilitate cooperation between Arab countries that are investing in and managing
the physical networks through the issuance of region-wide licenses for a market that
would be large enough to attract global players. A regional effort to agree to the creation
of a common competition authority may help to identify private collusive arrangements
and public policies that restrict competition on regional markets.
The sequencing of reforms will be important to make and sustain progress. One
possibility is to start with a regional effort on trade facilitation (broadly defined to include
25



key government 'services' that influence trade transactions costs), followed by initiatives
to promote more effective competition on the regional market for network-type service
industries and to liberalize entry into markets through investment (establishment).
Starting with trade facilitation puts pressure on only a small subset of the civil service
and will benefit foreign and domestic producers equally. Red tape costs large represent
social waste-they do not generate revenue or rents. Consequently, reducing these costs
can benefit the economy substantially.
As documented by Zarrouk (2002), trade costs in the region are high, in part
because of government imposed restrictions and controls at the border, and in part
because Qf a lack of competition in port, transport and related services. This is an area
that is generally recognized as a priority by the private sector. Regional cooperation in
this area could help governments move forward by setting quantitative benchmarks for
improvement, establishing mileposts and creating transparency and oversight
mechanisms to monitor progress achieved. Cross country experience suggests that
moving forward to facilitate trade by addressing regulatory and logistics restraints
requires high-level engagement by political authorities, something that is difficult to
sustain. A regional initiative could help ensure that the necessary attention and support is
provided over time, as the needed reforms will generally take a substantial amount time
as well as resources-for training, upgrading of hardware and infrastructure, and so forth.
To the greatest extent technically possible, regional initiatives should aim to
reduce costs for all trade and all traders, irrespective of origin. The primary rationale for
undertaking this effort in a concerted fashion is to create clear focal points and objectives,
and to mobilize the high level support that will be needed to make progress. There is no
rationale for differentiating between goods of Ar,ab and other origin-trade facilitation
should apply on a most-favored-nation basis. The same applies to services reforms more
generally-these should be applied on a nondiscriminatory basis.
A second potential area for regional cooperation is to develop mechanisms to
increase the contestability of markets, especially for 'backbone' infrastructure services.
Examples of such cooperation could involve the establishment of regional regulatory
agencies to oversee network services (telecommunications, electricity, railways and other
critical "backbone" activities). Regional regulatory agencies could facilitate cooperation
26



between Arab countries that are investing in and managing the physical networks through
the issuance of region-wide licenses for a market that would be large enough to attract
global players. Arab economic integration could also be a vehicle through which regional
competition disciplines are agreed and enforced to discipline private collusive
arrangements and public policies that impede entry or restrict competition on regional
markets.
A regional effort to liberalize 'backbone' services could start with defining the
"relevant market" in a more appropriate way. For instance, liberalizing air transport
without liberalizing airport slots does not lead very far: the price of air travel will mirror
both competitive pressures in terms of routes (if there are several airlines in presence,
which is not necessarily the case) and monopoly rents related to airport slot monopolies.
The same is true for maritime transport- Francois and Wooton (2000) estimate that the
welfare gains from trade liberalization (better access to markets) may be doubled if
complementary actions are taken to increase competition in the shipping sector. These are
all examples of the types of interactions that tend to be ignored by national sectoral
regulators and could be addressed more efficiently in a region-wide approach.
4.     Lessons from the EC experience
The EC experience suggests careful consideration will need to be given to the design and
sequencing of regional cooperation on services policies. Although a central pillar of the
EC integration strategy was preferential merchandise trade liberalization, a common
external trade policy and common management of agriculture, the EC also covers
services and factor flows (investment and movement of workers). 14 A number of lessons
can be drawn from the EC experience.
First, there must be an overarching vision with respect to the ultimate objective of
the exercise. Second, a clear path or strategy to achieve the objectives must be developed.
Third, the implementation of the strategy must result in an overall balance of gains for
14 Another option is to focus on liberalization of trade in factors of production, something that is not
discussed in this paper. Trade in labor services has traditionally been relatively important among Arab
countries, albeit hampered by significant barriers and high transactions costs (Schiff, 1996). There are close
links between temporary movement of people and liberalization of trade in services. What is required in the
case of labor services is primarily a relaxation of quantitative restrictions-imposed through visas and
economic needs tests and investment controls.
27



members at any point in time. This will require flexibility and may imply a need to carve
out some sectors from the liberalization objective (as agriculture was by the EC). Rather
than simply exempting 'difficult' sectors from the ambit of the customs union, the EC
brought them under the umbrella of the integration goal through a common policy
approach that was administered by the EC institutions. To a significant extent, the joint
management of these common policies became the focus of day-to-day interaction at the
Community level and helped make the EC a 'reality' for national bureaucracies and
stakeholders. In addition, the EC developed transfer mechanisms that redistributed
income to disadvantaged groups and regions. Finally, the supranational nature of the EC
was important in maintaining the venture over time-a self-interested bureaucracy that
was given a mandate to pursue integration proved very effective at mobilizing support for
new initiatives, while enforcement of the 'rules of the game' was pursued via the
independent ECJ.
The EC experience illustrates that regional cooperation to liberalize trade and
investment in services is hard. The Common Market was limited to goods-although the
manufacturing sector accounted for less than one third of EC GDP. Most services
(representing the lion's share of GDP) were left untouched by intra-EC liberalization
until the 1990s. In part, this reflected the fact that many service providers in the EC were
public monopolies (or firms to which member states granted special or exclusive rights).
While these were subject to specific Treaty provisions on state-owned enterprises and
state aids, only in the late 1980s did EC member states begin to embark on a major effort
to privatize and introduce regulatory reforms for services. Following Article 52 (ex 63),15
the EC focused primarily on only a limited number of service sectors-those perceived as
constituting the "infrastructure" backbone of the,economy: financial services, telecoms,
and transport (land, air, and sea). The late 1990s witnessed painful (and not always
successful) efforts to extend the list to electronic commerce, electricity and natural gas,
railways, and postal services.
In the Arab context, it is very difficult to assess ex ante which sectors will be
'sensitive', where there is a commonality of interest, and what is the balance of national
28



gains and potential losses (adjustment costs). This will require detailed analysis and
extensive political debate and discussion. However, a case can be made that national
interests regarding services reforms should be relatively balanced. In all countries, many
industries stand to benefit significantly from services liberalization and policy reform.
Manufactures and agricultural producers should have a strong interest in seeing their
input costs decline and the variety and quality of services offered increased. They can
therefore be expected to be a powerful force supporting regulatory reforms in services if a
credible case can be made that the integration effort will result in such outcomes.
This will require the elimination of entry barriers created by explicit
discrimination (e.g., no right of establishment and FDI) and regulatory differences that
result in market segmentation. Doing so in a cooperative manner is difficult. Perhaps the
most powerful force that can be unleashed through an integration process is to increase
competition through relaxation of entry constraints-explicit barriers as opposed to
implicit ones created by regulatory differences-and the adoption of mechanisms to
discipline state aids and anticompetitive business practices. This would require
institutions of the type created by the EC to monitor and challenge the behavior of
governments, and to address anticompetitive practices by incumbent firms. State aids and
intervention, as well as an absence of effective competition legislation, are two important
factors in many Arab economies. This suggests that in terms of common institutions and
disciplines attention should focus on those areas. Another priority area for institutional
cooperation and development relates to dispute settlement. As mentioned in Section 2,
the ECJ played a major role in advancing the integration effort in the EC. Without a
mechanism to enforce commitments on FDI and entry into services, the effort will
inherently be much less credible to the private sector, both in- and outside the region.
The feasibility of rapid movement to emulate the institutional complexity that
prevails in the EC is of course limited. In the EC, this has grown incrementally, and the
same would be true in the Arab context. Cooperation in regulatory areas andcommon
competition policies will undoubtedly only emerge gradually. What matters most in this
connection is to agree on the vision and to launch the process. This could encompass
15 Article 52 (ex 63), reads: "Priority for liberalization shall as a general rule be given to those services
which directly affect production costs or the liberalization of which helps to promote trade in goods." It
29



possible 'half-way houses' that could be used to build support for pro-competitive
reforms. One option could be a regional mechanism to increase the transparency of
government policies, including assessments of the economic effects of regulations and
other policies that limit competition. Such information is a necessary condition to
mobilize national constituencies that are negatively affected by such policies.
Mechanisms to generate such information are discussed in Hoekman and Mavroidis
(2000).
Whatever the specific features and modalities of cooperation, the economy-wide
benefits of services reforms will be greatest if regional reforms and disciplines are
applied on a nondiscriminatory basis. In contrast to preferential liberalization of trade in
goods, concerted services reforms are less likely to give rise to serious trade and
investment diversion, insofar as policies will often be applied equally to both foreign
(non-regional) and regional suppliers. A reason for this is that regulation should be aimed
addressing market failures, and thus be applied on a nondiscriminatory basis. The same
will often be true in practice for policies affecting the major mode of contesting service
markets-FDI. These generally do not distinguish between foreign investors on the basis
of nationality. However, in principle this can certainly be done, and on the investment
front such discrimination is pursued (on paper) in the Arab League context through an
Arab rule of origin (a minimum required Arab equity ownership share). It is important
that such discrimination be minimized.
5. Concluding Remarks
Arab economic integration efforts that revolve around merchandise trade liberalization
face substantial impediments: (i) markets are genierally small; (ii) strong comparative
advantages in certain products (natural resources) generate export concentration and
require geographical diversification of exports beyond the region to reduce risk; and (iii)
major Arab countries do not appear to have strong incentives to take the lead. in pursuit of
merchandise trade-based economic integration, while smaller countries that do have the
incentive do not have the influence to ensure implementation. Arab countries confront an
incentive structure that is quite different from what prevailed in the context of the
again illustrates the predominance of trade in goods as the focus of the EC process.
30



creation of the EC in the 1950s, suggesting that emulating the EC approach-one that is
based on preferential merchandise trade liberalization and the creation of a common
external merchandise trade policy, leaving services reform for later-is unlikely to be a
fruitful strategy for Arab countries.
For Arab economic integration efforts to be successful there must be sufficiently
large domestic coalitions that favors it over all alternatives (Galal, 2000). Given the
limited magnitude and potential for intra-Arab trade-and thus political support for
efforts to expand such trade-complementary instruments and approaches are needed.
One option discussed in this paper is to focus on the service sector-defined to include
both government and major 'backbone' infrastructure-type services. Integration efforts
that focus on services could potentially generate large gains that are a multiple of those
that could be obtained from preferential merchandise trade liberalization (Konan, 2002).
Indeed, preferential trade liberalization is unlikely to generate significant benefits-the
best trade policy strategy for the region is to pursue nondiscriminatory liberalization. The
latter is critical for many countries in the region-trade barriers are among the highest in
the world outside of South Asia and anti-export bias is consequently strong.
A key question concerns the need for a regional or concerted approach to services
reform. The incentives to pursue such reforms are large, and other parts of the world have
implemented service sector reforms on a unilateral basis. However, progress in this area
has been slower in Arab countries, suggesting there are political economy constraints that
are more binding. To become an engine for Arab integration, the joint pursuit of services
reforms will have to be an effective vehicle to help overcome political economy
resistance to unilateral reforms.
The European experience illustrates that for integration strategies to be successful
and to be sustained, powerful constituencies must see such efforts as contributing to the
realization of objectives they care about. While political objectives were paramount in the
EC, their realization involved the identification of economic measures that benefited all
citizens in an average sense, while ensuring that concerns and interests of key 'blocking'
coalitions and groups were satisfied. The challenge for supporters of Arab economic
integration initiatives will be to identity objectives that are supported by citizens, and
mechanisms of regional cooperation that will attain those objectives. Decision makers
31



must be able to make a compelling case that "going regional" will generate significant
benefits that cannot be realized through unilateral action.
While there is certainly potential for a services-based approach to generate such
benefits, it must be recognized that the design and implementation of concerted action
will be complex. A major lesson of the EC is that the pursuit of political objectives may
come at a high economic cost-the Common Agricultural Policy is an example. An
integration path that focuses on service markets therefore should be designed so as to
minimize the scope for capture by-and creation of-vested interests. In this regard there
is less potential for trade diversion under a services strategy as regulatory reforms will
often be applied on a nondiscriminatory basis. It is important that this be the case, as
discriminatory regional regulation may result in economies becoming locked-in to less
efficient regional suppliers and standards that impede the ability of more efficient foreign
firms to contest the market at a later date even if the discriminatory policy is removed
(Mattoo and Fink, 2002).16
Any regional approach to services reforms must recognize the fact that many
Arab countries have now signed agreements with the EC and that many are also engaged
in negotiations on goods and services trade in the WTO. The Euro-Med agreements all
include provisions calling for the development of disciplines for investment
(establishment) and services trade. They also embody numerous provisions calling for the
EC to provide cooperation and technical/financial assistance in trade-related regulatory
areas. These agreements can and should be taken into account in the design of any Arab
integration strategy. Indeed, while the focus here has been on Arab cooperation options, a
similar strategy can be pursued in the context of agreements with major high-income
economies such as the EC and US. Deep integration agreements with such partners may
well give rise to greater benefits through enhanced credibility effects and the likely
associated financial and technical assistance transfers that will be associated with them
(World Bank, 2000).
16 Mattoo and Fink (2002) discuss a number of issues that affect the sequencing of preferential and
multilateral liberalization of services. They point to the potential problem of negative path dependence if
preferential liberalization in services occurs for network industries with sunk costs-the end result may be
durable entry restrictions against more efficient non-regional suppliers.
32



More generally, an Arab services integration-cum-cooperation strategy can and
should be anchored in the WTO to ensure that policies are applied on a nondiscriminatory
basis wherever possible. Of course, making commitments in the WTO allows
concessions to be obtained from trading partners, expanding the potential gains from
committing to reform. Given that the focus of negotiations at the WTO is on the depth of
policy "bindings," the fruits of regional reforms can be used as negotiating coin.
Anchoring domestic liberalization in the WTO can also help Arab countries make reform
more resistant to backsliding (as negatively affected foreign suppliers will oppose
domestic efforts to re-impose trade barriers). That said, it must be recognized that WTO
negotiations on services have not progressed very far to date, general disciplines on
investment and competition policies do not exist, and many of the regulatory service
reform priorities remain outside the ambit of the WTO.
33



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3 5



Table 1: Overview of economies in the Middle East and North Africa: trade aspects, 1998
WTO      Population    GDP             GDP           Goods & services [b]    Trade       Shares of natural resources
Countries [a]     status [a]  (millions)   $Mn         per capita ($)   Exports    Imports     openness       in total exports (%)
[b]        [b]       [c]      $ Mn       $ Mn     ratio (%) [d]  All      Fuels  Non fuel
1          2           3          4         5         6          7           8          13       14        15
Natural resource-poor countries
Israel **         **1962        5.8       98973      17064     15920     32085      40763        73.6       1.9       0.6      1.3
Turkey            **1951       62.5       198006     3168      2780      49021      55894        53.0       3.9       0.9      3.0
Cyprus             **1963       0.8        8970      11649               3948       4639         95.7       8.9       0.3      8.6
Lebanon */**        no         3.1         8352      2660      2660                                         11.3      1.4      9.9
Morocco*          **1987       27.3       35546       1302     1110      8133       9675         50.1       13.2      2.1      11.1
Tunisia           **1'990       9.2       19936      2162      1820      8464       9103         88.1       16.0      15.0      1.0
Intermediate countries
Jordan 9/9*        *2000        5.8        7306       1266     1510      3548        5090       118.2       34.7      0.0      34.7
Egypt*            **1970       62.1       82710      1332       790      13932      19274       40.1        53.2     48.5      4.7
Bahrain9          **1993       0.6         6184      10307               4838       4202        146.2       67.3      37.1     30.2
Oil-rich countries
Syria9/9            no         15.0       69112      4623      1120      21498      21756       62.6        81.7     80.7      1.0
Oman *              no         2.4        14192      5913      4820      5508       5826        79.9        83.0     82.7      0.3
UAE*              **1994        .6        44673      17315     17400                            141.5       85.1     83.1      2.0
Iraq                no         21.2
Iran                no         60.7       187423     3088                15494      15650        16.6       85.6     85.1      0.5
Yemen *             no         16.5        5729       348       260                              91.5       90.0     89.4      0.6
Saudi Arabia *      no         19.5       128377     6587      7040      45605      39434        66.2       90.5     90.2      0.3
Qatar *           t*1994       0.6        9193       16128                                       73.2       93.3     93.3      0.0
Algeria              no        29.1       41158       1417     1600
Libya               no          5.8                                                              NA         96.3     96.3      0.0
Kuwait            **1963       2.0        25523      12890     17390     11380      12217       92.5        96.7     96.6      0.1
Memo items                                                                (avg)
All countries        --       277.9       950205     3190      2062                              80.6       68.3     66.8      1.5
GAFTA9               --       222.6      497991      2237      1799                             87.5        --        --       --
Sources: IMF, International Financial Statistics. World Bank. WTO-Trade Policy Reviews. UN COMTRADE.
Notes: [a] *: Greater Arab FTA (GAFTA) Members, **: GATT (*9) or WTO (*) membership and accession
dates.[b] [c] in millions of US dollars, at current exchange rates. Year 1995 for Algeria, 1997 for UAE, Yemen, Qatar, Bulgaria and Poland.
[d] Estimates (for 1995) from World Bank Development Report. te] Ratio of the sum of exports and imports over GDP.
36



Table 2 Structure of exports: product concentration and differentiation
Share of SITC            Index of concentration [b]   Intra-industry trade index [b]  Share of components in total
items exported (°/O) [a]                                                                 industrial trade (%/o, 2000)
1980      1997               1980        1997               1988        2000              Imports     Exports
Natural resource-poor countries
Israel  -        0.84      0.84               0.26       0.28                0.64       0.62                19.5       19.0
Turkey           0.79      0.93               0.23        0.10               0.22       0.31                12.5        3.9
Cyprus           0.50      0.46               0.15        0.15               0.22       0.32                12.8        3.1
Lebanon          0.81      0.67               0.16        0.13               0.26       0.18                11.8        3.5
Morocco          0.42      0.66               0.32        0.18               0.14       0.24                19.2        2.5
Tunisia          0.53      0.75               0.48        0.21               0.23       0.29                14.4        7.4
Intermediate countries
Jordan           0.45      0.47               0.35        0.27               0.09       0.16                18.4        8.5
Egypt           0.33       0.68               0.57        0.28               0.07       0.18               24.7         3.1
Bahrain          0.24      0.45               0.79        0.63               0.24       0.18                16.5        6.9
Oil-rich countries
Syria            0.44      G.45               0.63       0.56                0.03       0.11                7.6         0.4
Oman             0.42      0.61               0.92        0.72               0.25       0.14                18.8       14.0
UAE              0.82      0.88               0.87       0.62                0.11       0.22               20.8        10.9
Iran             0.37      0.72               0.81        0.80               0.02       0.08               25.6         2.2
Yemen                                                                        0.02       0.03                19.6        6.7
Saudi Arabia     0.77      0.73               0.94        0;74               0.13       0.13                19.0        7.1
Qatar            0.01      0.30               0.93        0.73               0.04       0.07               20.4         3.7
Libya            0.18      0.12               0.96        0.77               0.03       0.04               21.3         1.6
Kuwait           0.79      0.65               0.72        0.56               0.06       0.07                17.0        3.9
Memo items
Malaysia        0.85       0.94               0.30       0.19                0.58       0.64               23.1        22.5
Korea           0.85       0.92               0.09       0.14                0.40       0.57               17.6        18.3
Taiwan          0.87       0.93               0.12       0.12                0.43       0.57               17.1        24.3
Sources: UNCTAD, Handbook of Trade Statistics, 1997 and 2000; UN COMTRADE.
Notes: [a] Percent of SITC items with "substantial" exports. [b] See text and footnotes for definition.
37



Table 3: Geographic Destination of Exports, 2000
Exports as % of Total Exports
World     All Indus  Indus.  North  Asia &  All Non-                     Arab    Latin   Not
Country         ($ Million)  Countries  Europe  America  Pacific Indus Co. Africa  Asia  Europe nations America Specified
Aigeria             20,468   83.4     66.7     16.5    0.2     16.6     1.3   0.8    6.2    1.1    8.2     0.0
Bahrain              5,701   16.8      6.9     5.6     4.4     83.2    3.4    27.4   0.6    9.7    0.2    42.1
Cyprus                 953   39.6     36.9     2.4     0.2     60.4    2.5    2.8   15.6   26.1    0.3    11.8
Egypt                5,633   61.1     43.8     14.9    2.4     38.9    2.6    11.2   4.5    9.7    1.0    10.8
Iran                28,345   43.7     25.6     0.9     17.3    56.3    0.0    30.0   3.9    7.5    0.2    14.7
Israel              31,910   69.6     28.6     37.7    3.4     30.4     1.5   15.3   4.3    0.3    2.9     6.1
Jordan               1,897    6.8      2.6     3.4     0.8     93.2     3.3   22.0   1.2   33.8    0.3    33.9
Kuwait              17,752   55.9     14.6     15.2    26.1    44.1    0.1    41.8   0.9    0.9    0.5     0.0
Lebanon                715   36.2     27.0     8.0     1.3     63.8    6.7    4.2    6.9   45.2    0.6     1.4
Libya               12,688   88.2     88.1     0.0     0.1     11.8    2.7    0.5    7.5    3.3    0.2     0.1
Morocco              8,228   73.6     62.7     5.9     3.7     19.0     1.3   8.5    3.3    4.4    2.4     7.4
Oman                10,542   22.5      1.3     2.5     18.8    77.5    0.9    63.4   0.0   13.1    0.0     0.0
Qatar               11,527 - 5i.0      1.1     3.7     46.3    49.0    0.8    31.9   0.1    6.3    0.1     9.8
Saudi Arabia        74,688   54.9     17.9     18.2    18.8    45.1    2.6    32.9   1.2    7.6    1.5     0.0
Syria                4,981   63.5     59.6     3.5     0.3     36.5     1.1   1.5   13.7   18.1    0.2     3.0
Tunisia              5,986   80.2     79.1     0.8     0.3     16.0    3.4    2.5    1.7    8.9    0.9     3.1
Turkey              27,768   66.4     53.4     11.9    1.0     33.6     3.2   2.9   11.2   .9.5    1.0     5.6
UAE                 41,068   42.0      5.1     2.4     34.5    58.0     1.7   32.6   0.8    9.7    0.2    13.3
Yemen Rep.           4,076   12.3      2.4     6.2     3.8     87.7     1.9   76.2   1.1    4.2    1.6     2.7
Total              314,926   56.3     28.8     12.5    15.0    43.4     1.8   24.4   3.4    6.9    1.5     6.1
All Developing  '2,075,378   53.9     23.7     17.2    13.0    46.1    1.7   28.7    6.3    5.0    4.2     0.1
Countries
Source: IMF, Direction of Trade Statistics Yearbook, 2001.
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Table 4: Trade Intensity Indices for Middle East and North Africa Countries' Exports in 2000
All Industrial  Of which: Industrial Countries  Developing countries
Country      Countries  Europe  N. America  Asia & Pac.  Asia       Arab
Algeria        1.25     1.77      0.74        0.03       0.04       0.40
Bahrain       0.25      0.18      0.25        0.66       1.56       3.54
Cyprus         0.59     0.98      0.11        0.03       0.16       9.52
Egypt         0.92      1.16      0.67        0.36       0.64       3.52
Iran          0.66      0.68      0.04        2.61       1.71       2.72
Israel         1.04     0.76      1.69        0.51       0.87       0.12
Jordan         0.10     0.07      0.15        0.12       1.26       12.34
Kuwait        0.84      0.39      0.68        3.95       2.38       0.32
Lebanon       0.54      0.71      0.36        0.19       0.24       16.47
Libya          1.32     2.33      0.00        0.01       0.03        1.22
Morocco        1.10     1.66      0.27        0.56       0.48        1.60
Oman           0.34     0.03      0.11        2.84       3.62       4.79
Qatar          0.77     0.03      0.16        7.00       1.82       2.31
Saudi Arabia   0.82     0.47      0.82        2.84       1.88       2.77
Syria          0.95     1.58      0.16        0.05       0.09       6.59
Tunisia        1.20     2.09      0.04        0.04       0.14        3.26
Turkey         1.00     1.42      0.54        0.15       0.16        3.48
UAE           0.63      0.13      0.11        5.21       1.86       3.53
Yemen Rep.     0.18     0.06      0.28        0.57       4.34        1.54
Al above     0.85      0.76      0.56        2.27       1.39       2.52
Note: Trade Intensity Index (T) is defined as: Tij = (xij / Xit) / (xwj / Xwt) where xij and xwj are the value of
country's (i) exports and region's exports to world (), Xit is the country's total exports and Xwt are the total
world exports. An index of more (less) than unity indicates trade flows that is larger (smaller) than
expected given the partnees importance in world trade.
Source: Computations based on IMF Direction of Trade Statistics Yearbook 2001.
39



Table 5: Regional Export Shares and Weight in GDP, 2000
Value of                  Exports to Arab   Exports to Arab
exports to Arab  Share in total countries as a share of countries as a share of
Country              countries ($ mill)  Arab trade (%)  total exports (%)  GDP (%)
Algeria                  224            1.2            1.1              0.4
Bahrain                  554            3.0           9.7               7.0
Egypt                    544            2.9            9.7              0.6
Iran                    2,117          11.3           7.5               2.0
Jordan                   642            3.4           33.8              7.7
Kuwait                   154            0.8            0.9              0.4
Lebanon                  323            1.7           45.2              2.0
Libya                    425            2.3            3.3              1.4
Morocco                  360            1.9           4.4               1.1
Oman                     1,386          7.4           13.1              7.0
Qatar                    731            3.9            6.3              5.1
Saudi Arabia             5,680         30.3            7.6              3.3
Syria                    900            4.8           18.1              5.3
Tunisia                  535            2.9            8.9              2.7
UAE                      3,981         21.3            9.7              8.3
Yemen Rep.               172            0.9            4.2              2.0
All Above Countries     18,728         100.0           7.4              2.7
Note: Regional trade refers to intra-Arab trade.
Source: IMF, Direction of Trade Statistics Yearbook, 2001 and World Bank, World Development
Indicators, 2001.
40



Appendix: Trends in Bilateral Trade, 1960-2000
The body of the paper describes the current pattern of trade between countries in the Middle
East. It is interesting to complete this picture by examining whether this situation has always
existed, and what has been happening over time. A comparison of intra-regional bilateral trade
flows over the last 35 five years suggests that there has been a significant decline in the relative
importance in intra-regional trade since the early 1960s, but that there has been a pick-up in the
last decade. A matrix of bilateral imports is reported in Appendix Table 1, with data aggregated
according to the natural resource-intensity of trading partners. Table 2 does the same for exports.
The region here is defined as all countries-not just Arab nations.
The data reveal two different types of evolution in imports from Arab economies. On the
one hand, countries that are not oil-rich witnessed a decline or stability of the share of their
regional trade until 1985, followed by a reversal since then, but generally not large enough to
counterbalance the previous decline. On the other hand, oil-rich countries tend to increase trade
with other Arab countries-an evolution which may reveal an income effect (oil-rich countries
may have been induced to diversify their purchases because of lower oil prices, and to turn
towards less expensive local sellers).
In the early 1960s, Lebanon and Jordan imported about 60 percent of all non-oil imports
from the region. By 1997 this had dropped to the 10-15 percent range. Note that many countries
register an increase in the intra-regional share after 1985. Increases are substantial for Syria, Iraq,
Oman, Saudi Arabia, Libya and Kuwait. The regional breakdown of exports also suggests the
long-term trend is down-most countries exported less in 1997 in relative terms to the region
than in the early 1960s (Table 2). The exceptions with respect to non-oil trade that show a
recovery in the last 10-15 years include Egypt, Syria, Saudi Arabia, Algeria, Libya and Kuwait.
In the case of Syria, Egypt and Lebanon, the increase involves non-oil economies, while for
Saudi Arabia the increase is in oil-rich countries (suggesting again growth of intra-industry trade
in oil-related products).
41



Annendix Table I: Intra-reeional imnort nattern Ipercentages). 1964-97
Natural resource-poor countries         Intermediate countries                Oil-rich countries                  Total regional
1964    1978     1985    1997      1964     1978    1985     1997       1964    1978     1985    1997       1964    1978    1985   1997
Intra- trade as a percentage of total trade (oil included)
Israel                     0.9     0.1     0.2      1.3       0.9      0.0     0.0      0.1       0.1      0.1      0.0     0.0        1.9     0.3    0.2     1.4
Turkey                     1.3     2.2      1.0      0.8       1.2     0.9     0.2      0.9        9.3     23.5    31.1     7.6       11.8    26.6    32.4   -9.3
Lebanon                    3.9     1.4      5.5     3.6       2.6      1.6     1.0      1.1       18.2     12.7     0.8     7.7       24.7    15.6     7.3   12.4
Morocco                    0.0     1.1      0.4     1.3       0.4      0.7     0.0      0.3        2.3      8.0    21.5    10.8        2.8     9.8    21.9   12.3
Tunisia                    0.2     1.9      1.2      1.8      0.5      0.1     0.4      0.6        5.6      5.3     7.4     5.0        6.3     7.3     9.0    7.4
Jordan                     7.5     6.7      4.2     4.6       2.3      1.9     0.5      1.3       12.9     15.4    25.8    21.2       22.6    24.0    30.5   27.1
Egypt                      0.5     2.0     1.1      2.0       0.0      0.2     0.2      0.2        5.2      1.9     2.0     4.6        5.7     4.2    3.2     6.8
Bahrain                    0.0     0.3      0.6     1.1       0.0      0.0     0.1      0.8       85.7    45.8     48.1    11.7       85.7    46.1   48.8    13.6
Syria                      6.6     4.1     2.5      6.8       2.6      3.0     0.6      2.2        8.8     9.6     27.2     5.6       17.9    16.7   30.2    14.6
Oman                       0.0     0.5      0.1     0.5       0.0      2.9     0.5      1.0       98.1     16.5    22.4    26.7       98.1    19.9    23.0   28.1
UAE                        0.0     1.0      1.7     1.1       0.0      1.4     4.1      0.4       93.3     2.8      4.4     6.3       93.3     5.2   10.1     7.8
Iraq                       2.8     1.8     11.7     5.6       1.4      0.9     2.2     15.3        1.8     0.7      0.1     3.1        5.9     3.4    14.0   24.0
Iran                       1.1     1.5     11.6     3.1       0.0      0.7     0.0      0.1        3.5      1.0     0.8     2.0        4.6     3.2    12.4    5.2
Yemen                      0.0     0.8      0.3     4.2       2.8      0.7     0.4      2.3       76.0    23.4      0.6     7.5       78.9    24.9     1.3   14.0
Saudi Arabia               6.2     1.8      1.8    10.6       5.7      0.8     1.2      0.1        8.0      1.4     1.9    23.3       19.9     4.1    5.0    34.0
Qatar                      1.3     1.0      1.5     0.4       0.0      0.7     1.1      0.9        4.6     4.3      5.6     6.4        5.9     6.0    8.2     7.7
Algeria                    2.6     0.3     2.3      3.9       0.2      0.1     0.1      0.5        0.2     0.2      0.4     3.4        3.0     0.7    2.8     7.8
Libya                      1.4    3.1      4.5      9.5       0.7      0.1     0.0      2.7       0.9      0.2      0.1     1.0        3.0     3.4    4.6    13.3
Kuwait                     2.8     2.0     2.2      2.5       1.3      1.0     0.6      1.9        5.4     1.6      0.1    11.4        9.6     4.6    3.0    15.8
Yemen, DR                  0.3     0.0     0.0        -        1.0     4.1     0.5       -       40.8     15.0      2.8      -        42.1    19.1    3.3
Intra- trade as a percentage of total trade (oil excluded)
Israel                     0.1     0.1 -   '0.2     1.4       1.7      0.0     0.0      0.1        0.1     0.2      0.0     0.0        1.9     0.3    0.2     1.5
Turkey                     1.8     1.2      1.5     0.8       0.3      0.4     0.3      0.3        0.4     0.3      1.0     1.9        2.4     1.9    2.8     3.0
Lebanon                   11.4     1.6     5.3      3.9       7.4      1.9     0.5      1.2      41.3      2.1      0.3     4.2       60.2     5.6    6.1     9.3
Morocco                    0.0     1.2     0.5      1.5       0.4      0.8     0.1      0.3       0.5      0.1      0.4     3.0        1.0     2.2    0.9     4.8
Tunisia                    0.4     2.0     1.1      1.5       0.7      0.1     0.4      0.6       2.5      0.2      1.9     1.9        3.6     2.3    3.4     4.0
Jordan                    24.8     7.5      5.4     5.4       8.9      2.1     0.7      1.5      33.4      6.5      5.8     8.7       67.1    16.1    11.9   15.6
Egypt                      0.6     2.1      1.0     1.8       0.0      0.2     0.2      0.2       4.4      1.8      1.0     4.1        4.9     4.1    2.1     6.1
Bahrain                    0.0     0.5     1.2      1.1       0.1      0.1     0.3      0.8      31.3      5.8      3.9    11.8       31.4     6.3    5.3    13.8
Syria                      8.1     4.7     3.5      7.1       3.2      3.5     0.8      2.3       10.0     0.6      0.7     5.2       21.3     8.7    5.0    14.6
Oman                       0.0     0.6      0.1     0.5       0.0      0.6     0.1      0.5       96.4    12.9     22.0    25.9        0.0    14.1   22.3    26.9
UAE                        0.0     1.1      1.8     1.1       0.0      0.5     0.7      0.4        1.2     0.7      2.8     6.2        1.2     2.2    5.2     7.7
Iraq                       1.3     1.8     11.8     5.6       0.7      0.9     2.2     15.3       0.8      0.7      0.1     3.1        2.8     3.4   14.1    24.0
Iran                       0.6     1.5     12.3     3.2       0.0      0.5     0.0      0.1        1.2     0.8      0.4     2.0        1.9     2.8   12.7     5.3
Yemen                      0.0     0.8     0.3      4.2      15.5      0.6     0.4      1.6       77.0    22.1      0.6     7.5       92.5    23.5    1.4    13.4
Saudi Arabia               1.6     1.8     1.9     10.9       1.5      0.8     1.2      0.1       2.1      1.4      1.9    23.8        5.2     4.1    4.9    34.7
Qatar                      0.3     1.0     1.5      0.4       0.0      0.7     1.1      0.9       0.7      4.3      5.5     6.4        1.0     6.0    8.1     7.7
Algeria                    2.5     0.3     2.3      4.0       0.2      0.1     0.1      0.5       0.2      0.1      0.4     2.6        2.9     0.5    2.8     7.1
Libya                      0.7     3.1     4.6      9.5       0.3      0.1     0.0      2.7       0.3      0.2      0.1     1.0        1.2    3.4     4.7    13.3
Kuwait                     1.0     2.0     2.2      2.5       0.5      1.0     0.6      1.9        1.9     1.6      0.1    11.1        3.4    4.6     3.0    15.5
Yemen, DR                  0.2     0.1     0.0       -        0.6      0.1     0.6       -        10.8     1.7      0.0      -        11.6     1.9    0.7      -
Source: Author's calculations based on UN COMTRADE database.
42



Appendix Table 2 Intra-re2ional exnort pattern. 1964-97
Natural resource-poor countries          Intermediate countries                  Oil-rich countries                   Total regional
1964     1978     1985    1997       1964     1978     1985     1997       1964    1978     1985     1997       1964    1978    1985   1997
Intra-trade as a percentage of total trade (oil included)
Israel                 1.9      1.8     0.6      1.1        0.0     0.0      0.2      0.4        1.5      2.8      0.0      1.3        3.3    4.7     0.8     2.8
Turkey                 5.8     4.1      2.3      3.2        0.6      5.9     2.4      1.3        1.3     12.6     56.7      7.3        7.7   22.6    61.4    11.8
Lebanon                2.0     2.3      1.2      6.8       15.5    14.1     12.4      7.6       76.5     69.8     50.6     16.2       94.0   86.2    64.3    30.6
Morocco                0.1     1.1      3.4      1.5        0.3     0.2      0.1      0.2        2.9      1.8      6.0      2.8        3.3    3.1     9.5     4.4
Tunisia               0.1       13      1.8      2.0        1.0     0.1      0.5      0.5        7.2      7.5      7.2      6.6        8.2    8.9     9.5     9.1
Jordan                25.0     5.5      2.6      9.8        0.1     4.9      1.2      3.4       57.3     65.5     50.1     42.7       82.5   75.9    53.9    55.9
Egypt                  3.4     3.5      0.6      9.0        0.6     1.3      0.3      0.6        3.7      8.0      2.3      6.4        7.7   12.9     3.2    15.9
Bahrain              21.3      0.0      0.3      1.2        0.4     0.0      0.4      1.3       33.5     16.9     27.4     5.1        55.2    16.9   28.1     7.7
Syria                 29.6     5.6      2.5     22.9        6.4     6.6      1.5      3.0       13.3     12.9      7.4     11.2       49.2   25.2    11.4    37.2
Oman                   0.0     0.0      0.0      0.0        0.0     0.5      0.2      0.3       10.6      0.4      1.0     14.8       10.6    0.9     1.2    15.1
UAE                    0.0     0.0      0.5      0.2        0.5     0.3      0.2      0.3       19.1      2.2      5.5      6.7       19.6    2.5     6.3     7.2
Iraq                   3.6     3.8     11.5      5.3        0.3     0.2      1.8     15.9        5.8      1.6      0.2      0.0        9.6    5.7    13.5    21.1
Iran                   1.7     2.3      9.1      3.8        0.1     0.1      0.0      0.1        6.8      0.6      5.8      0.7        8.6    2.9    14.9     4.5
Yemen                  0.0     0.0      0.0      0.0        1.0     0.4      0.1      0.5       55.1     35.4     12.9      0.3      56.1    35.7    13.0     0.8
Saudi Arabia           2.5     0.7      2.6      2.7        4.5     2.7      6.3      1.3        1.3      0.9      0.5      3.2        8.3    4.4     9.4     7.2
Qatar                  9.9     0.0      0.1      0.3        4.0     0.2      0.3      0.3        62       1.0      3.7      0.7       20.2    1.2     4.2     1.3
Algeria                1.3     0.0      2.3      6.4        0.3     0.0      0.0      0.0        0.2      0.0      0.1      1.9        1.9    0.1     2.5     8.3
Libya                  0.7     2.6      5.9      8.4        1.0     0.0      0.0      0.7        0.2      0.1      2.8     0.4        2.0     2.8     8.6     9.5
Kuwait                 0.2     0.3      1.6      1.5        1.7     0.5      0.9      0.2        4.8      3.3      3.1      1.7        6.7    4.1     5.7     3.4
Yemen, DR              0.5     0.0      0.0       -         0.3     0.1      0.0       -         9.8     59.4      0.8      --        10.6   59.5     0.8      -
Intra- trade as a share of total non-oil trade
Israel                 2.2     0.2      0.6      1.1        0.0     0.0      0.1      0.3        1.8      3.0      0.0      1.4        3.9    3.2     0.7     2.7
Turkey                 4.3     4.1      2.7      3.2        0.5      5.9     3.0      1.3        1.3     12.6     69.6      7.3       6.1    22.6    75.2    11.8
Lebanon                1.0     1.6      1.2      6.9        8.3    14.2     12.4      7.7       49.7     70.5     50.6     16.4       58.9   86.3    64.3    31.0
Morocco                0.1     1.0      3.1      1.3        0.2     0.2      0.1      0.2        2.4      1.8      6.1     2.8        2.7     3.0     9.3     4.2
Tunisia                0.0     1.9      2.6      2.0        0.7     0.1      0.7      0.6        6.4     11.0     10.4      7.2        7.2   13.1    13.6     9.8
Jordan                17.4     5.5      2.8      9.8        0.1     4.9      1.3      3.4       40.2     65.5     54.5     42.7       57.7   75.9    58.6    55.9
Egypt                  5.4     5.7      1.6      6.0        1.1     3.5      1.2      1.1        6.1     19.3     10.7     11.8       12.6   28.5    13.6    19.0
Bahrain                0.0     0.0      1.1      2.0        0.6     0.0      1.4      2.0       74.4     33.6     36.2     6.5       75.0    33.7    38.6    10.5
Syria                 55.1     3.6      4.3     28.7       10.5     19.5     6.5     10.4       25.7     38.5     31.8    31.5       91.3    61.6    42.6    70.6
Oman                   0.0     0.0      0.0      0.0        0.0     11.3     4.2      0.3       70.5     10.1     30.0     15.0       70.5   21.4    34.2    15.3
UAE                    0.0     0.0      0.4      0.6        0.0     9.6      2.4      1.1       26.7     59.7     59.4    29.3       26.7    69.2    62.2    31.0
Iraq                   7.9     1.0      2.1      0.5       2.8     17.0     18.0     27.0       36.6     11.5     11.5     0.1       47.4    29.6    31.6    27.5
Iran                   Lr6     0.8      2.6      3.4        0.2     1.1      0.9      0.5        8.4      8.4     15.4     4.5        10.2   10.2    18.9     8.4
Yemen                  0.0     0.0      0.0      0.7        1.3     0.4      0.2      7.9       40.2     39.8     40.6     6.9       41.4    40.2    40.8    15.4
Saudi Arabia          19.4     0.6      2.5      3.8       56.6    10.9      5.6      8.9        9.7     33.4      5.0    24.0       85.7    44.8    13.1    36.7
Qatar                  1.5     0.0      1.4      1.5        0.0     5.6      3.7      2.5       62.1     25.0     41.9      6.3       63.6   30.6    47.1    10.3
Algeria                1.4     0.6      6.2     16.9        0.3     0.4      0.0      0.1        0.3      1.0      0.1     9.7         1.9    2.0     6.3    26.7
Libya                  1.2      1.7    14.2     16.9        1.8     5.1      0.1     10.6       11.6      1.5      1.1      3.7       14.6    8.3    15.3    31.3
Kuwait                 4.1     5.5      0.3      5.3       25.4     11.9     7.2      4.0       57.1     56.7     35.9    41.5       86.5    74.1    43.4    50.8
Yemen, DR              1.0     0.0      0.0       -         0.8     0.2      0.1       -        32.9     83.7      6.6       -       34.7    83.8     6.7      --
43












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