A quarterly magazine of the IMF

March 2003, Volume 40, Number 1

High unemployment in the MENA region presents formidable challenges for policymakers

The population of the MENA region is one of the fastest growing in the world. It has nearly quadrupled since 1950 and is expected to double over the next 50 years. However, jobs have not grown as fast as the region's workforce. Employment growth was relatively strong in the 1970s, but it began to lag population growth in the 1980s, when oil prices dropped and government-led growth strategies fizzled out. The region entered the 1990s with relatively high unemployment rates, which have continued to climb in most countries. The average rate for the seven largest non-oil or diversified economies in the region—Algeria, Egypt, Iran, Jordan, Morocco, Pakistan, and Tunisia (hereinafter referred to as the MENA7)—rose from 12.7 percent in 1990 to 15 percent in 2000 (see table). Moreover, underemployment (lack of adequate job opportunities for workers) remains pervasive.

The bleak job picture is one of the region's most urgent and destabilizing problems, fueling social tensions and migration and making job creation a top priority. But policymakers face some difficult questions. Is it possible to increase the employment content of GDP growth, or will faster GDP growth be required—and, if the latter, how much faster? Will the current pattern of job creation—a large proportion of the region's workforce is employed by the public sector—need to change? An examination of the experiences of the MENA7 over the 1990s sheds some light on these and other questions. Together, these countries account for about 80 percent of the population and of the output of the region, excluding the GCC countries, whose economies and employment challenges differ from those of the rest of the region.

New jobs were being created at a much faster rate in the MENA7 than in most other developing regions during the 1990s—over 2.6 percent a year. But the working-age population grew even faster, at a rate of 2.9 percent a year (Chart 1). This rate is expected to edge down but will do so only gradually, and demographic pressures will continue to weigh heavily on the region's labor markets.

The challenge of MENA's rapidly expanding population has been compounded by the growing participation of women in the labor force. As social attitudes evolve and a greater number of girls and women are educated, the number of women working outside the home is increasing. During the 1990s, female participation rates in the workforce increased by 6 percentage points in Algeria; 5 percentage points in Jordan; 4 percentage points in Egypt, Pakistan, and Tunisia; and about 2 percentage points in Iran and Morocco.

At the same time, male participation rates declined, leaving the average total labor participation rate at around 50 percent. The reason for the reduced participation of men in the workforce in these countries is likely to vary from country to country, but, in some, a lack of attractive job opportunities may have played a role. Thus, the severity of the unemployment problem is probably greater than indicated by the observed gap (about ¼ of 1 percent a year) between employment growth and labor force growth.

Labor market surveys indicate that rising unemployment has hit mostly first-time job seekers, particularly those with a secondary education. This suggests that unemployment is predominantly the result not of economic restructuring but, rather, of the countries' inability to create jobs fast enough to accommodate new entrants into the labor force. It may also reflect the willingness of educated youths to wait for jobs in the formal and public sectors to open up and to register themselves as unemployed in the interim, as well as the educational system's failure to provide its students with the kinds of skills needed for private sector jobs.

The public sector remains a main source of job creation. On average, public sector employment accounts for about 20 percent of total employment and about one-third of non-agricultural employment in the seven countries. The share is higher in Algeria, Egypt, Iran, and Jordan. The evidence suggests that the share of the labor force employed in the public sector may have increased in some countries over the 1990s, as private sector growth stagnated and governments were forced to become employers of last resort. Thus, although governments have contained public sector wages, the government wage bill as a percent of GDP has continued to rise in the seven countries. At about 11 percent of GDP, on average, it is one of the highest in the world.

At the macroeconomic level, the employment growth rate was relatively high in relation to GDP growth during the 1990s. The implied elasticity of employment (the ratio of employment growth to GDP growth) was 0.7 for the MENA7, roughly the same as for developing countries in the Western Hemisphere, compared with around 0.4 for the United States and developing countries in Asia (excluding China), 0.3 for the European Union, and 0.1 for China. However, labor productivity growth (roughly, the difference between GDP growth and employment growth) was relatively low—about 1 percent a year, on average, during the 1990s—limiting the potential for real wage growth (Chart 2).

Indeed, some evidence points to declines in real wages in the manufacturing sectors of Algeria, Egypt, and Jordan during the 1990s. The weakness of labor productivity growth appears to have resulted from both a slowdown in the rate of capital accumulation and weak growth in total factor productivity (productivity gains from the more efficient use of capital and labor, and technological progress). More detailed microeconomic analyses would be necessary to identify the sectors in which productivity grew slowly, but the overall result may indicate that underemployment and low-productivity jobs in the informal sector have increased.

The continued strength of government job creation—in the government sector, measured productivity gains tend to be lower—may also have been a factor in the slow growth of overall labor productivity. The three countries with the lowest rates of labor productivity growth (Algeria, Egypt, and Jordan) are also the ones with the largest shares of government employment. By contrast, Iran and Tunisia have had relatively high rates of labor productivity growth, which reflect relatively high rates of total factor productivity growth (1–1½ percent a year). In Tunisia, productivity growth is likely to reflect efficiency gains from the gradual liberalization and opening of the economy to competition, whereas, in Iran, total factor productivity growth during the 1990s appears to have been driven by the gradual absorption of unused capacity.

The weakness of productivity growth during the 1990s is particularly striking in light of the region's educational gains. Although countries in the Middle East and North Africa still lag behind developing countries in Asia and Latin America in terms of educational achievement, particularly for women, they have made impressive strides since 1975. The average number of years of education completed by those 15 years of age and older in Algeria, Egypt, Iran, Jordan, Pakistan, and Tunisia more than doubled between 1975 and 2000, compared with an average increase of about 50 percent in other developing countries. On average, the return on investing in education thus appears to have been low, suggesting that educational systems may not have adequately prepared students to meet the requirements of modern market economies. The large proportion of university students with degrees in human and social sciences in MENA countries may be symptomatic of a skill mismatch.

The solution to these countries' unemployment problem is closely connected to an improvement in GDP growth performance. Sustained reforms undertaken since the 1980s and 1990s by most countries in the region have improved the climate for growth, most notably by restoring and maintaining macroeconomic stability, raising literacy rates, and increasing the private sector's role in the economy through such measures as privatization. Yet the private sector's response in terms of growth and job creation has been disappointing, particularly in comparison with more dynamic emerging market countries.

How much more GDP growth would be needed to address the employment needs of the region over the medium term? Reducing unemployment rates by half over the next 15 years while meeting the job needs of new entrants into the labor force would require that average employment growth increase to about 4 percent a year in the MENA7. This could be achieved through a significant compression of real wages, but the social cost would be unacceptable. If the twin objectives of creating jobs and improving living standards are to be achieved, a leap in GDP growth of roughly 2 percentage points a year over the recent trend of 3.7 percent annual growth will be required.

What policy reforms can enhance growth prospects? Although countries in the Middle East and North Africa have made progress in opening their economies to private activity, they can do much more to increase competition and productivity growth. Public enterprises still play a dominant role in these countries, and private sectors are often shielded from competition by restrictive trade regimes and other anticompetitive policies. By accelerating privatization, liberalizing external trade, and removing restrictions on foreign companies' access to domestic markets, the countries can strengthen competition, which, in turn, would increase productivity and spur economic growth.

Institutions also play a key role in growth. But institutional reforms in the Middle East and North Africa have been lagging, and legal, administrative, and institutional obstacles weigh heavily on the private sector. To the extent that such constraints impair competition and encourage rent seeking rather than entrepreneurship, they hurt competitiveness and dampen growth. "Second-generation" reforms aimed at creating an investment climate more hospitable to innovation and competition appear to be the key to unlocking the region's growth potential. These reforms include adopting a modern legal and regulatory framework for property rights, foreign direct investment, and financial transactions; establishing a competent and independent judiciary system; introducing a fair, transparent, and effective tax system; and eliminating bureaucratic intrusiveness and corruption.

Are labor markets in the Middle East and North Africa flexible enough to allow enterprises to adjust to stronger competition and innovation? The evidence is mixed. Real wages in the industrial sectors of selected countries appear, in fact, to be quite flexible, and labor market regulations, while widespread, are generally no more prevalent than in other developing countries. Moreover, the impact of regulatory rigidities on aggregate employment tends to be muted by the presence of large informal sectors. Nonetheless, rigid labor market regulations in some countries could become a binding constraint on growth and employment during times of structural transformation by interfering with enterprises' ability to adjust to changing market conditions. In these circumstances, targeted labor market reforms, in combination with the creation of more competition in the private sector, could have a significant payoff. The social considerations that underlie many labor market regulations would need to be addressed through a more effective social safety net for the unemployed.

Are there costs to sustaining employment through the public sector? The preponderant role of the public sector in most of the countries in the region may well be a natural policy response to lackluster job growth in the private sector and may therefore be difficult to reverse unless the private sector begins to expand. At the same time, public employment policies impose costs on the private sector and distort incentives in ways that can harm growth. These considerations would argue for a gradual retrenchment of public sector employment. The most obvious cost of large public sector employment is that it has to be financed through larger deficits, higher taxes, or decreases in other, potentially more productive, public spending. Because of the premium placed by public sector jobs on educational achievement rather than marketable skills, the attractiveness of public sector employment (in terms of job security and, in some countries, relatively high wages) may also have contributed to creating a skill mismatch relative to the educational requirements of the private sector. The skill mismatch, in turn, increases pressures on the public sector to absorb graduates unable to find jobs in the private sector.

The significant pickup in growth needed to create more jobs over the medium term calls for ambitious, broad-based reforms. Opening the private sector to stronger competition while strengthening the institutions that support private markets can encourage investment and stimulate productivity growth. The positive impact on employment, in turn, can be enhanced through targeted labor market reforms aimed at ensuring that enterprises can adjust to market signals. In this process, the role of the public sector will need to be reshaped, from that of purveyor of jobs to that of provider of sound physical and institutional infrastructure.