One of the most potent threats to Middle East stability doesn't come in a canister or chemical-weapons factory. It wasn't hatched by militant Islamists inside madrasas or sleeper cells. It is largely ignored by diplomats and heads of state, yet it figures more prominently among Arab concerns than America's war on terror. And toppling Saddam Hussein can't possibly solve the problem.
IT IS CHRONIC ILLIQUIDITY-the main source of rising unemployment and stagnant economies in the Arab world. The problem is not merely weak revenue, but a lack of modern banks and financial tools to lure cash out of burgeoning black markets and into the faltering daylight economy.
From Syria to Morocco, Arab financial institutions are too primitive and regimes too inept to meet their economies' basic need for capital. Arab banks are reluctant to lend money, and Arab stock markets hardly trade. Starved of cash and burdened by overvalued currencies that price their goods out of world markets, Arab manufacturers export well below their potential. The Middle East's share of global trade is stagnant, and trade between Arab countries make this the only region in the non-developed world where the broadest measure of the liquid-money supply is dropping (charts). Foreign investors have abandoned Middle East equity, and foreign direct investment in the 22 Arab economies is now less than half the global average, as a percentage of gross domestic product.
No matter what happens in or to Iraq, a worse region-wide crisis is brewing. From 1990 to 1999, the per capita value of Arab economies grew at just under 1 percent while their populations grew by 4 percent. If the Arab economy cannot absorb its growing population of idle and increasingly angry youths, the Middle East will remain a sanctuary for militants just as moderate, middle-class Arabs flee the region. "The Arabs are going the way of Africa," says Taher Gargour, a Middle East analyst for HSBC Investment Bank in London. "You only have to draw a straight line from where the Arab economies were a century ago to where they are now to get an idea of where they're going-and the answer is very worrisome."
From the death of Muhammad in the early seventh century to the end of the Fatimid dynasty 500 years later, Arab Muslims presided over the most prosperous empire The World had yet seen. It reached from the Strait of Gibraltar to the Central Asian steppes, and its subjects included Jews, Christians, Persians and the peoples of the Mediterranean. The Arabs occupied a land bridge between the developed economies of the East and the primitive markets of the West. Arab kilns and looms produced ceramic bowls, glassware, ironwork and textiles. During the Crusades, reported the Spanish geographer Ibn Jubayr, Christians and Muslims traded in peace and civility even as "the warriors are engaged in their war." Arab currency was held from Scandinavia to China, and a draft order signed against an account in Damascus would be honored in Canton. These were known in Arabic as sek, from which the English "check" is derived.
The free flow of goods and money informed the character of early Islam. Part of Muhammad's appeal was his reputation as an honest merchant, and the hajj, or pilgrimage to Mecca, was big business. "May your hajj be accepted, your sins be forgiven and your merchandise not remain unsold," went a salutation of the period. The Dome of the Rock in Jerusalem was commissioned by caliph Abd al-Malik largely to divert pilgrims from his commercial rivals in Mecca. "The Muslims of the last period were more active and reasonable than they are now," says Suheil Sakkar, a professor of Islamic history at Damascus University. "Arab industry-textiles, smiths, jewelers, carpentry-was a source of great profit. This is what made them a great civilization."
As late as the collapse of the Otto-man Empire a century ago, the Levant was a robust economy of 40 million people with no borders to impede the flow of goods and services. On the eve of World War I, Egypt's trade was worth nearly half its GDP, a ratio close to that of Britain then and greater than South Korea's today. Now it is just 8 percent of GDP and falling (yet still higher than those of most other Arab nations). The question, then, is: what happened to the Arab economy?
The Arabs no longer have anything-save oil-that The World wants to buy. Most Arab products like textiles, building materials and foodstuffs are made largely for domestic markets and are inferior to exports from Asia or Latin America. Those that are competitive can't find the capital to grow. Decades of government bungling have chased so much capital underground or into exile that bankers are afraid to lend and borrowers have given up on finding credit. The result is an increasingly premodern, oil-dependent, cash economy.
Arabs are fleeing with their money at an alarming pace. In Lebanon, up to 3,000 people between 25 and 50 years old emigrate each month. According to a report from Cairo investment bank EFG-Hermes, there was as much currency coming into Egypt from 1991 to 1998 as there was going out. In the next three years, $15 billion fled the country. "We are forecasting an economic crisis in five years," says Omar Abdullah, a coauthor of the report. "It will be a turning point. The least painful option will be [an International Monetary Fund] bailout. I'm no fan of the IMF, but compared to the government's capability, it would be a blessing."
The grim state of affairs has deep roots. After World War I, Britain and France divided the Arab region into tiny emirates-of-influence. In carving up the Arab map, the Europeans sired a litter of new national economies with their own centralized systems of laws, taxes and fiscal management, which created a commercial dissonance that prevails today. Syrian agriculture products, for example, are often kept out of markets in neighboring Lebanon because of laws aimed at protecting Lebanese farmers. The Arab League has tried to dismantle barriers that estrange Arab economies from each other, but with little success. The British and French, according to economists Roger Owen and Sevket Pamuk, "put an end to the system which, in Ottoman times, had permitted almost complete free trade between Anatolia and the Arab provinces of the empire."
The cold war further isolated the Arab world. In 1958, in defiant response to U.S. President Dwight Eisenhower's demand that Arab leaders stand with America or with the communists, many Arab states turned to Soviet central planning. It was the climax of Arab experiments with socialism that began when Egyptian colonel Gamal Abdel Nasser took power in a 1952 coup and nationalized the economy. The architect of Egyptian socialism was technocrat Aziz Sidqi, who in 1960 pioneered a five-year plan that put industries from steel to Arabian horse breeding under state control.
Egypt was to the Middle East what Japan was to Asia: the model everyone else followed. Sidqi's initiatives so undermined the Egyptian economy that by the late 1970s it could no longer sustain its defense budget, and in 1979 Anwar Sadat was forced to make peace with Israel. In return, Cairo demanded-and won-generous aid from the West, without having to reform its economy. Egypt emerged from the cold war with a shoddy industrial base and bureaucrats ill prepared for an increasingly competitive global market. Sidqi's regime left Egypt with little export revenue to pay for necessary imports, and the country fell deeply into the red. By 1987 Egypt was spending 70 percent of its meager export earnings to pay external debts, and was forced to enter an IMF-World Bank debt-rescheduling program.
By then, Arab governments had started losing control of their economies. The oil boom of the 1970s masked the inability of Arab regulators to audit capital and use tax revenue to provide basic services. Today's petro-states keep solvent by selling oil as fast as they can pump it. Others survive on a vast gray market. In many ways Iraq is one of the most dynamic economies in the Middle East because of an enormous smuggling trade that has evolved around more than a decade of United Nations sanctions. Lebanon and Syria maintain a huge underground trade in everything from illegal drugs to agricultural goods.
The collapse of oil prices in the 1980s, and the Arab response to it, helped set the stage for today's looming liquidity crunch. Petroleum-producing states were forced to cut back on investment, which reduced the wages Arab guest workers in the Persian Gulf were able to remit back home, drying up a crucial source of capital in the non-oil-producing Middle East. Rather than cutting interest rates to stimulate demand,
Arab governments kept credit tight and local currencies strong to pre-empt rising prices and social unrest. The need for stable currency rates cost Arab central banks a fortune in foreign reserves and rendered Arab exports uncompetitive. Some Arab governments tried to borrow and spend their way back to health. Now Lebanon's debt burden is equal to 170 percent of its GDP, and Jordan's is 100 percent, which means they can ill afford to address the liquidity problem by lowering interest rates.
Meanwhile, years of war and central planning eroded what were once world-class financial systems. Arab banks are risk-averse, and formerly efficient credit markets are stifled by Nasserite red tape. When the Middle East peace process began in the early 1990s, Arab pledges of reform encouraged investment bankers to promote the Middle East as the next big emerging market. After a few big privatizations, the regimes slowed reform and investors departed for Eastern Europe and East Asia.
The challenge today is how to revitalize those dormant financial systems and harness the Arab world's huge reservoir of unreported capital. In "The Mystery of Capital," economist Hernando de Soto focuses on the problem of Egypt's "dead capital," though he could be writing about nearly all the Arab states. "Outside Cairo," de Soto writes, "some of the poorest of the poor live in a district of old tombs called ‘city of the dead.' But almost all of Cairo is a city of the dead-of dead capital, of assets that cannot be used to their fullest. The institutions that give life to capital-that allow you to secure the interest of third parties with your work and assets-do not exist here."
Talk to any Arab businessman, and he will trace the root of the problem back to dying capital markets. Abdel Raof Essa is the owner of Domiat Egypt Co., one of the top companies in Damietta, a port famous for furniture makers. Family-owned for four generations, Domiat copies chairs, desks, bureaus and commodes that embellish the palaces of Europe. It started exporting a decade ago, and last year all of its $3 million in sales went to buyers in the West and Japan. This makes Domiat-which is based in a concrete blockhouse adjacent to a stable of goats, donkeys and water buffaloes-one of the relatively few Arab companies that make things The World wants to buy.
You'd think Egypt would promote Domiat aggressively. But no. Like other manufacturers throughout the Middle East, Domiat is plagued by the legacy of state planning: high taxes on imports, an inept monetary authority, cautious bankers. Rules on importing wood are so strict that Essa has to hire a special agent just to store his materials. The cost of the agent might be partially offset by a tax refund for exporters, but auditors never respond when Essa applies for one. "This government is worse than useless," he says. "Our ministries don't help us, and our embassies do nothing."
Essa would turn to private financial markets to expand, but none exist. To buy equipment or material, he has to use his own money. Lacking enough property for collateral, he has a tough time getting a bank loan. He cannot take out a second mortgage on his home because mortgages don't exist in Egypt; the government recently passed a mortgage law, but long-term retail lending has yet to evolve. He wouldn't think of raising money by listing on the Cairo and Alexandria Stock Exchange, where shares trade at record lows. "We are on our own," says Essa.
"We're lucky because we have been exporting for some time and know the business. But those who rely only on the domestic market are very weak now. They have no revenue at all."
That beggars the government, too. In Egypt, estimates of gray-market commerce run as high as 30 percent of the official GDP of $87 billion. "What this means is that the economy does not respond to monetary and fiscal stimuli," says Mahmoud Mohieldin, adviser to Egypt's economics ministry. "Ninety percent of Egyptians don't care about a tax cut, because few ever pay taxes except for a sales tax. So you can reduce taxes as we are doing, but it will have no impact, and that erodes the credibility of the government's ability to manage the economy."
There's not much credibility left. Take forward markets, which would allow companies to hedge against currency swings that now plague the economy as the government loses its battle to protect the Egyptian pound. Egypt once had The World's third largest futures exchange, in Alexandria, but it was closed under Nasser and has yet to revive. "A forward market has been on the table for the last three to four years, but nothing is done," says Munir Fakhry Abdel-Nur, the managing director of Vitrac, a jam maker battered by the rising cost of imports as the pound falls.
The Abdel-Nur family owns 35 percent of Vitrac's listed stock, which is stable mainly because the market is in a deep sleep. The index has lost half its value over the last two years, and daily turnover has declined from $250 million to about $20 million. No one expects a turnaround soon. Egyptian shares trade at some of the lowest multiples in The World-three times earnings, five times earnings-yet still there are no buyers.
So moribund is the exchange that Naguib Sawiris-one of three brothers who run the Orascom Group, Egypt's biggest conglomerate-is trying to delist his shares by purchasing them in the market. Orascom companies account for 20 percent of the market's capitalization. "They're trading at 10 percent of their value, and [exchange regulators] are saying I have to pay the original list price," Sawiris says. "They're making it up. This is the problem with Egypt. There is no faith in the government's ability to manage the economy."
Even Lebanon, once known as the Hong Kong of the Middle East for its nimble banking system, is parched of liquidity. Nazem Ghandour returned home to Lebanon in 1992 from studying in London to help rebuild his father's sugar refinery after two decades of civil war. Within three years the mill had captured half the country's sugar market. When sales declined after the government began to subsidize smaller, less efficient refiners, Ghandour's banks called in their loans. "We took all the financial precautions," he says. "We were hedged, but the financiers failed us. That is the reason most Middle East businesses fail." Ghandour planted mushrooms on the site of the closed refinery and has since become Lebanon's top mushroom farmer-but he had to borrow the seed money from friends and family.
At least Lebanon has commercial banks. Neighboring Syria, which only just passed a banking law and is now taking license applications from foreign banks, has none. Inspired by the Soviets, the government channeled funds to state-run enterprises, in large part to prevent the Sunni business class from getting too powerful. As a result, there is no such thing as credit in Syria. Shop owners carry their take home each night in plastic bags. Couples pay for homes with suitcases full of cash. The winner of the annual lottery picks up his winnings in bundles of bills and carts them off in vinyl luggage. Syrian manufacturers are among the most sophisticated in the Arab world, but non-oil exports are worth only 7 percent of its $17 billion GDP. According to Jordanian economist Riad al Khouri, the average factory worker in Syria generated $9,900 in revenue annually in the five years ending 1999, almost no change from $9,600 a decade earlier.
In the Syrian port of Latakia, Haitham S. Joud and his brothers run Joud Trading Co., a maker of washing machines, dryers and refrigerators for export to Europe. Sales are good and the company plans to use its own cash to expand, rather than apply for a loan from banks in Beirut, which charge notoriously high interest. "We do 80 percent of our transactions in cash," says Joud. "We're lucky we have it. Smaller companies have to go to the gray market. They can't even borrow against their homes."
Like other Arab regimes, Syria talks about reform but does little to follow through, fearing the loss of control that would come with real change. So the government satisfies itself by reveling in the past; at the grand opening of Damascus's annual trade fair, political leaders celebrated themselves as the progeny of the commercially savvy eighth-century Umayyad clan, the first of the three Arab-Muslim dynasties. "Compared to the present, those times look pretty good," says a Western diplomat in Damascus. In recent years, while Syria has claimed annual growth of 2 percent, Western embassies privately figure the economy is shrinking by 2 to 4 percent.
It will come as a relief if the economic decay leads only to liquidity crises and IMF bailouts. At a minimum, the post-World War II rise of radical Islam coincided with economic decline and intensified with the collapse of oil prices in the mid-1980s. Religious militants were never much of a problem in the days of the caliphate. True, there were the Kharijites, or Outsiders, who murdered the nephew of Muhammad and spent the next centuries plundering caravans and killing the odd minor official. The hashish-smoking Assassins stalked powerful figures as different as Saladin and King Richard the Lionheart, rivals of the Third Crusade. But in general, Arabs were too busy with trade to pay much attention to the radical fringe.
It may seem arcane, with war hanging over Iraq, to dwell on dead capital in the Arab economy. Indeed, there is an economic argument to be made that freeing Iraq from Saddam could unleash the potential of a nation that was once the industrial heart of the Arab world. But the effect would be fleeting without deeper change, and rehydration is the key. Far from bankruptcy, the Arab world is awash with cash. If the United States wants to address the root cause of Arab malaise, it might convert the billions of dollars in aid it showers each year on Israel, Egypt and Jordan into narrowly defined programs aimed at modernizing financial institutions that can leverage the region's vast and inert hidden capital. Washington could also quit rewarding Arab regimes that have plundered their economies and throttled enterprise with inept leadership and oppressive government. Those measures would give the growing pool of dangerously idle Arab youths some hope of finding jobs, and the dwindling middle class a reason to stay and rebuild.
UNREAL ESTATE: DREAM HOUSE
Construction has stopped on Beit Palestine, or House of Palestine, the grand mansion commissioned by Munib Masri, a patriarch of the most influential Palestinian family on either side of the Jordan River. Nearly complete and perched atop the highest mountain in Nablus, the villa seems to levitate, Olympus-like, above a city that was known as the industrial heartland of the Palestinian territories before the current intifada shut it down, along with the rest of the West Bank.
The mansion is an extravagant monument to the Masri family vision of a rich Palestine emerging from the economic decay of the Middle East. Masri, a flamboyant 68-year-old, has embroidered Beit Palestine with luxury trimming - fireplace mantels, statues, tiled floors - all collected from his travels in Europe. Thousands of wooden crates containing baroque and Victorian fixtures are stacked on the grounds, awaiting installation. Think Hearst Castle in the Holy Land and you get the idea. Once finished, says Masri, Beit Palestine will open its doors to the Palestinian people. "I have an obligation to them," Masri says, scampering up a catwalk to the main dining room. "When the Israelis tear out a tree, we plant a tree. When they destroy a house, we build a house." Even an unfinished Beit Palestine is a hopeful symbol to Palestinians, particularly compared with the devastation of Yasir Arafat's compound, leveled by Israeli forces last month.
The Masri family, with Munib and his 64-year-old second cousin Sabih at its head, has been the leading investor in the Palestinian Authority and Jordan since the Arab-Israeli peace process began a decade ago. Arab leaders hailed Masri investments as a valuable peace dividend. Even now, Sabih Masri in particular continues to invest, against the counsel of some family members. Sabih says the Masris can afford to bet on the region since most of the family fortune is invested elsewhere, particularly Saudi Arabia and the United States. But he acknowledges the risks.
"I'm an optimist," he says from his office, adorned with Southeast Asian antiques. "At the end of the day, Israel will have to accept the fact that peace is inevitable."
Many Palestinians have invested in their homeland, but few if any are so powerful as the Masris. Sabih has close links to the monarchies in both Saudi Arabia and Jordan and is friendly with Lebanese prime minister and real-estate mogul Rafik Hariri. Maher Masri, Sabih's nephew, is Yasir Arafat's trade minister. Another nephew, Taher, has served as Jordan's prime minister. Munib's current home in Nablus, where he awaits the completion of his mansion, is considered one of the few places Arafat will sleep without a bodyguard present.
The Masri empire has been expanding rapidly since Sabih made a fortune supplying the U.S. Army during the 1990 gulf war. Their holdings now include hotels, telephone grids, water projects, supermarket chains, port developments, an investment bank and auto dealerships scattered about the West Bank and Jordan. Most significantly, Sabih Masri owns critical water rights and is poised to play a role in what one day could be the region's most vital asset: a pipeline linking the Dead Sea and Red Sea that would provide the region with fresh water for generations. "Both King Abdullah and Arafat know the economy is the issue and Sabih Masri is one of the biggest investors in the region, if not the biggest," says Mahmoud Awwad al-Kharabsheh, a Jordanian lawyer and parliamentarian. "No one can outbid Sabih Masri. His money allows him to influence important decision makers."
In a region dominated by largely unpopular leaders, the Masris are genuinely admired. Sabih favors cabs over limos, and Munib and his two sons are involved in a rare Israeli-Palestinian joint effort, planning a day-care center in the Old City of Jerusalem. Israelis tend to see the Masris as a force for moderation. Palestinians see them as an authentic Palestinian voice - one wealthy enough to command Israeli respect.
The Masri influence wasn't always so dominant. In 1990, with a weak global economy and the first intifada raging, their prospects looked grim. At the time, says a person close to the Masri family, "Sabih couldn't cover a .20,000 check." Then the Masri luck turned, thanks to Saddam Hussein.
After Iraq's invasion of Kuwait in August 1990, Masri leveraged his contacts as a food distributor for the Saudi Arabian Army to win an exclusive contract to provision U.S. troops during Operation Desert Storm. In six months, say people close to the enterprise, Sabih Masri made a billion dollars. Masri won't comment, except to say, "I'm a lucky man."
The end of the gulf war raised hopes that the Middle East would become a hot emerging market. It was a heady time for Palestine Development and Investment Ltd., or Padico, a holding company launched in 1976 by Sabih Masri and other investors. Padico controls critical local assets, including the telephone monopoly and the stock market, which enjoyed a bull run in 1999.
Now, Padico is struggling to survive the second intifada. It has a 35% stake in the Jacir Palace-Intercontinental Hotel, a 19th-century landmark that reopened in September 2000 after a $US55 million ($100 million) restoration, only to be shuttered almost immediately by clashes between Palestinian youths and Israeli troops. Padico's agribusiness has been devastated by Israeli road closures, which delay shipping and send the rate of chicken deaths and egg spoilage skyward. Yet Sabih continues to buy local. "Sometimes," says Taher Masri, the ex-prime minister , "I will remind Sabih of the political risks. But he keeps his own counsel."
Perhaps Masri's most vital asset is water rights in a desert kingdom facing a dire water shortage. Though Masri has said he'd be happy to sell his stake in the Disi Reservoir, which is costly to maintain, its value could be inestimable once Jordan, the Palestinian Authority and Israel resume work on the $US6 billion Dead Sea-Red Sea water pipeline, in addition to desalination plants estimated to be worth several billion dollars. "Masri is thinking about the long term," says Labib Kamhawi, an ethnic Palestinian trader in Jordan. "Whoever controls water in this region controls the region." No family has risked more than the Masris on what now looks like slim prospects for peace. But none stand to gain more if the dream comes true.