Go West to find an answer to the problems of the Middle East

25 June 2004
I shall take my vacation next month in the American West and expect to find three things: wide open spaces, cheap gasoline and lots of fat people. It is a journey to recover lost faith. Washington's demented Middle East policy has got to me. I've almost had enough and need reassurance in the Rockies.

My mood has been worsened by the US' Middle East initiative. It says the region is misgoverned, hopeless at economics and it's all its own fault. But let's look at the record. If you start from the early 1980s, as the critics always do, growth has been weak. But if you use 1973 as the baseline, Middle East growth has been higher than in most parts of the world despite a dozen wars.

In the GCC, which accounts for half of Arab gross domestic product (GDP), annual growth has been about 7 per cent since 1995. Critics say this is due to higher oil production and prices. But what's wrong with that?

The usual answer is it means the Middle East can avoid reforms. But will the reforms deliver? British economic growth since it was first measured in the 19th century has been remarkably stable at about 3-4 per cent a year despite radical policy shifts. At the start, it was a protectionist police state, then went free market crazy, launched into globalism, adopted central planning to beat the Kaiser and Hitler and ended with a privatisation binge. So many policies. So little impact on economic performance.

Two things determine long-term growth: technology and resource endowments. Companies never invest enough in developing IT because it's risky and has low returns. They prefer to buy it. The competitive technology advantage of nations is mainly the result of state intervention and is rarely permanent. Where would America's IT industry be without US defence spending? Which other nation can afford to do the same?

Managing the national capital and labour endowment offers more options. Americans are proud of their living standards. But US wages have always been high. It is because Washington was efficient in taking land from the original inhabitants. This led to a high capital/labour ratio, which drove up wages because there was a lot of land and not many workers. Without abundant, cheap capital in the form of the depopulated prairies, mountains and forests I will see this summer, Americans would have been as poor as everyone else.

President Reagan, the subject last week of history's cheesiest funeral, was credited with defeating the Soviet Union with ideas. The truth is that it was bankrupted by the fall in oil prices after 1985. Now that oil is up, Russia is recovering.

A country with fixed capital endowments, surplus labour and no technology advantage can only lift growth by improving its terms of trade. The US has mastered this art, manipulating world markets to ensure its companies, farmers, consumers and wage-earners are advantaged and selectively using overwhelming force to achieve its goals.

For the Middle East, lifting the oil price is the swiftest way to growth. The impact on the world economy has been modest. Americans still enjoy reasonable gasoline prices, which is why I can afford a long motoring excursion. No one in the US is losing weight involuntarily. Middle America is materially flourishing.

Champions of the Middle East initiative say reforms are justified because free markets support free people. But nothing undermines fair government more than poverty. Average Middle East per capita income is about $3,000 a year, little more than a 10th of the European level. Democracy has no chance so long as people live in misery.

The initiative will fail because its priorities are wrong, putting abstract concepts above bread-and-butter issues. It will destabilise the region's most populous countries. It sets out an economic agenda that Middle East countries have sampled and found wanting.

The Middle East needs permanent change in its terms of trade. If a decisive improvement in relative wages compared with the OECD is impossible and emigration for the majority is blocked, the only option is a lasting rise in the price of oil and gas, its principal hard currency earner.

It is the option the clever people behind the Middle East initiative fail to mention. And it is the one that will do more to encourage political progress than all the initiatives in the West.

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