Governments across the Middle East and North Africa (Mena) region have focused their attention in recent years on making a good showing on the World Bank’s Ease of Doing Business report. The report recognises states that have done the most to reduce red tape and smooth the process of establishing new businesses.

In recent years, a surprising number of Arab states have moved up to compete with leading states like Singapore, Hong Kong and New Zealand, those with the most robust commitments to removing shackles on their private sectors.

In the past six years, 94 per cent of the 18 Arab economies ranked in the 2012 survey have made their regulatory environments more business-friendly.

Ease of starting a business

Since 2005, the number of Arab economies where starting a business takes 20 days or less has more than doubled, from four to 11. Regulatory and institutional reforms have reduced entry barriers in Egypt, Libya, Morocco, and Saudi Arabia. Morocco has led the way in banking reform, Egypt in tax and Yemen in business entry, says US consultancy Booz & Co in a report on job creation in the Arab world published earlier this year.

These collective efforts represent an attempt to ease restrictions confronting small businesses in an economic landscape that has traditionally been dominated by state-owned enterprises (SOEs) and large family-owned firms that often enjoy privileged access to resources.

However, the battle to cut red tape continues to prove a challenge and more work is needed to stimulate enterprise in the region.

While Mena states have made impressive strides in lowering the cost of doing business, some of the more impressive performers such as Egypt and Tunisia have lately been dealing with the fallout of the Arab Uprisings. Tinkering with the investment climate does not translate automatically into broad-based economic development.

You need this reform of governance in order to make [state-owned enterprises] accountable

Nasser Saidi, Dubai International Financial Centre Authority

Undertaking the reforms to lower the cost of doing business and removing barriers to make it easier for private sector companies to register and operate is only one part of the equation, says Nasser Saidi, chief economist at the Dubai International Financial Centre Authority and executive director of the Hawkamah Institute for Corporate Governance.

“If you don’t have access to finance, what difference does it make if you can register a business in five days or one month?”

A lack of inclusiveness undermined the effectiveness of governments like Mubarak-era Egypt, which made privatisation a central component of its economic policy. “In the case of Egypt, the people who benefited most from that were those around Mubarak and the people in power. Privatisation, instead of yielding the benefit of private sector expansion, created a private sector monopoly,” says Saidi.

If the region’s governments are serious about incentivising the private sector to become long-term generators of economic growth, more decisive steps will be required. Since small and medium-enterprises (SMEs) are intended to emerge as the prime source of job creation, this is where much of the attention is focused.

Governments need the right mix of incentives and tax breaks to encourage SME development focused on generating jobs for locals. Those sectors that have been actively fostered as part of state-led economic diversification strategies have yet to generate significant jobs growth. The biggest success stories of the past decade – financial services, construction, real estate – have tended to benefit expatriates rather than nationals. 

Under Saudi Arabia’s national development plan, support for SMEs is a central objective, via the Kafalah programme run by the Saudi Industrial Development Fund (SIDF). A collaboration between the Ministry of Finance, the SIDF and Saudi banks, the programme seeks to promote financing to SMEs by offering loans of up to SR2m ($533,000). Simultaneously, the SIDF-Kafalah programme will issue a guarantee to the bank, covering up to 80 per cent of the loan amount. 

Bank loans for small businesses

The government wants to reach 10,000 SMEs through the Kafalah system over the next 10 years and redress past failures at directing concessionary financing to the sector. Between 2006 and 2010, barely more than 1,000 Saudi SMEs applied for bank loans. 

The World Bank’s private sector arm, the International Finance Corporation (IFC), has a strategy to focus its investment towards SMEs.

“We believe SMEs in the Mena region are completely underdeveloped. They represent about 90 per cent of all businesses, but when you look at bank lending to SMEs, only 20 per cent of all loans in the region are to SMEs. That is a very low proportion,” says Mouayed Makhlouf, the IFC’s Mena region director.

Our region needs to create 100 million jobs in the next 20 years …  the only solution is the private sector

Majid Jafar, Crescent Petroleum

Another strategy is to encourage SMEs to merge and benefit from economies of scale, since the small size of many SMEs is constraining them from accessing finance. This relative weakness of Mena’s SMEs contrasts with strength of large, state-backed companies. Enjoying privileged access to resources, state-owned enterprises (SOEs) have crowded out SMEs. In parallel to building up the SME sector, governments are being urged to address the dominant role of SOEs, for example by removing the protection afforded to them, by enforcing strict budget constraints and exposing them to open competition. These are tough decisions, but some governments are taking the necessary steps.

State firms in the Middle East

Morocco and Egypt, for example, have established codes of governance for their SOEs, although actual implementation will be key.

The issue of board composition of SOEs is important, says Saidi. In many instances, these are political appointees that lack the required skills and levels of competence. “Boards have very important functions. If you include political functionaries or government bureaucrats, you won’t get the best results. What you want are people who understand the nature of the business and who can guide an SOE.”    

The ownership function needs to be well defined because without it, the work of SOEs can be subverted. Clarity is needed on the ownership structure of SOEs and whether they report to a ministry or central agency. 

“You need this reform of governance in order to make them accountable, but also to prevent bribery and corruption because SOEs are major sources of spending for governments, involving billions of dollars’ worth of investment projects,” says Saidi. “If you want to combat bribery, corruption and waste, good governance, supervision and accountability of SOEs is a perfect starting point.” 

For dynamic private sector firms to emerge into a space occupied by SOEs, they have to overcome another obstacle: the privileged status of family-owned businesses. These companies secure their revenue streams via agency representation agreements with foreign companies. This is also not conducive to creating jobs for nationals.

State financial assistance to encourage family businesses to go public or privatise would improve transparency and governance, as well as enable them to expand and diversify, says Said al-Shaikh, a Saudi economist and Majlis al-Shura member. It would also boost their growth prospects through merger and acquisition opportunities.

Greater size provides for greater growth, says Al-Shaikh. “Once privatised, this would also encourage mergers among companies operating within the same industry in order to create larger entities …. Firms would become more competitive and create more jobs as they grow.”

However, family businesses generally do not yet see this as a priority. “They think they can obtain resources as and when they need them, but without investing in training and research,” says Al-Shaikh.

Governments need to focus on areas where there is the strongest fit between job creation and where the state is no longer best placed to play a leading role. Infrastructure is an example and public-private partnerships (PPPs) in Egypt and Kuwait has been a step forward.

“Infrastructure can be a game-changer for the region. Historically, we have underinvested in infrastructure. I’m in favour of a major programme of investment in roads, ports and airports and everything related to that. This strategy will create jobs and support private sector expansion,” says Saidi.

Public private partnerships

The state would be left to play a background role, operating as regulator. However, private investors will not be queuing up to participate in infrastructure PPP projects without reform to the public sector. Investments will have to be profitable or they are unlikely to commit. This will need strong commitment from the state.

Backers of PPPs are confident that post-revolution governments across the region recognise the value of the PPP schemes launched by their predecessors. The IFC met with Egyptian Prime Minister Hisham Qandil late in August.

“From our conversation it was clear that they value the private sector as the engine of growth. They see the value of it and see their role as facilitating growth and encouraging investment in the private sector,” says Makhlouf.

“We’ve met with ministers in Tunisia and its definitely top of their priorities. Regardless of which governments come and go, the private sector will have to step up to the plate.”

The need for a pro-private investment policy is clear, says Majid Jafar, CEO of Crescent Petroleum, a major non-state oil company active across the Mena region. “Our region needs to create 100 million jobs in the next 20 years, which is more than we have created in the last century. The state sector is bloated, so the only solution is the private sector.”

The challenge is huge. “There’s a lot that needs to be done to empower the private sector to grow and absorb that bulge,” says Jafar.