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Risk in the Arab world: enterprise vs politics

Tarek Osman
9 November 2007

The Arab world's economic record in recent decades is a story of failure. Despite an exponential leap in its population, which has become increasingly youthful as a result, it has been unable to pioneer on its own account any of the ingredients of a modern, dynamic economy: new technologies, value-added concepts, international trends, recognisable brands, creative intellectual property, theoretical breakthroughs in any serious discipline, or - with a handful of exceptions - wealth-creation vehicles that extend outside its borders.
Tarek Osman is an Egyptian investment banker covering the Gulf and UK markets.

Also by Tarek Osman in openDemocracy:

"Egypt: who's on top?" (7 June 2005)

"Egypt's crawl from autocracy" (30 August 2005)

"Hosni Mubarak: what the Pharaoh is like" (16 January 2006)

"Can the Arabs love their land?" (22 May 2006)

"Egypt's phantom messiah" (12 July 2006)

"Mahfouz's grave, Arab liberalism's deathbed" (23 November 2006)

"Egypt: a diagnosis" (28 June 2007)

Why should this be? This article focuses on the question of enterprise and its relationship with the political order in Arab countries, to ask whether the constraints on risk-taking are a key factor in inhibiting the Arab world from realising its economic potential.

An impulse blocked

In spring 2007, a leading member of the executive committee of the Gulf Venture Capital Association commented that the key challenge for members of his organisation is "deal flow" - i.e. the flow of business ventures in which the venture capitalists could invest. The association's spring "collective basket" (the aggregate number of applications received by the members of the association between January and April 2007) was "significantly below expectations".

The same broad problem was encountered by a young Egyptian entrepreneur with a top-notch American business education and experience who returned to Egypt few years ago to establish one of only a handful of well-capitalised venture capital firms in the country. After two years of striving to source interesting transactions, he deemed Egypt lacking in entrepreneurial flair - and left.

The story is not much different on the western fringes of the Arab world. The International Finance Corporation (IFC), the private-sector arm of the World Bank, has sought to boost entrepreneurialism (and thereby economic dynamism) in the Arab world by launching the Private Enterprise Partnership (PEP), an initiative aiming to help entrepreneurs and promote small businesses, mainly in north Africa. However, the PEP is so far not doing that; it predominately funds infrastructure projects, albeit on smaller scales, rather than innovative ventures established by young, bright Arabs.

The Levant, historically the Arab world's bastion of innovation, especially in trade, has had a declining effective GDP per capita (on purchasing-power parity) for decades. Today, Lebanon and Syria are not hotbeds of innovation in trade, shipping, finance, or commerce; rather, they are major producers of skilled, relatively cheap labour in a steady migratory stream to the Gulf.

But the Gulf itself, which is floating on an ocean of liquidity in its current oil boom, is hardly a breeding-ground for new, innovative ideas. The vast majority of the Gulf's liquidity continues to be invested in stable, low-risk asset classes, such as real-estate and branded-retail, or passively monitored as it is channelled to western money-management firms. Arabian Business, a Gulf-based business publication, contained a report in 2006 on the new ideas emerging out of the Gulf; the two key listings were a new fashion store (basically a distributor of a number of luxury brands), and a new hotel chain.

A faculty missed

The economic retardation of the Arab world is quite striking. It is the only region in the world, with the exception of sub-Saharan Africa, with such a cheerless record. Two main phenomena illuminate the picture.

The first is that Arabs are not taking risks for the purpose of creating job opportunities and wealth. And that is strange. One would expect that for a region of 250 million people, more than 50% of whom are under 35 and more than 40% of whom are under the international poverty line; a region with an unemployment rate of more than 25%; a region where foreign direct investment is minuscule, and thereby attractive employment opportunities are rare; a region with significant excess in liquidity - one would expect that in such a region there would be a striving, hard effort to seek new opportunities through the creation of new ventures, the development of new ideas, and the embrace of risk. But that is not happening.

The second phenomenon is that the region as a whole, the aggregation of the socio-economic activities of its inhabitants, is not innovatively productive; it is not producing new ideas, ventures, products, investments, or services that effect any socio-economic leap.

Those two phenomena reinforce what the second edition of the Arab Human Development Report had stated: entrepreneurial activity in the Arab world, on the micro level (the emergence of sole proprietorships or partnerships as independent economic entities) or the macro level (the emergence of major economic trends that extend across and beyond the region and as such result in massive creation of wealth) is very limited.

A number of processes, economic in general and socio-economic in specific, has been proposed as lying at the root of this dearth of entrepreneurialism. These include:

* the poor education that makes access to capital (or informed advisors) close to impossible

* the concentration of economic power in almost every Arab country in the hands of very small percentages of each country's population

* the skewed distribution of wealth

* the crushing of the middle class in many Arabic societies

* the difficult, and at times degrading, lifestyles of millions

However, my personal observation suggests that another variable is at play in the problem: taking significant risk in the current political and economic environment of the Arab world is irrational.

A game unplayed

It is salient to define what the fundamental ingredients of entrepreneurialism are. There are numerous definitions and descriptions, but I am a fan of a classic one by Gus Levy, a legendary managing partner of the American investment bank Goldman Sachs: "an entrepreneur is someone who has got the guts to make that dream of yours a reality - for him". Not the most refined, but it encapsulates the crucial aspect: "guts" - courage, drive.

According to behavioural sciences, most people are neither risk-takers, nor risk-averse; they are risk-neutral: their appetite to undertaking risk is directly related to the upside potential associated with the risk in concern. There should be a balanced relationship between the risk and the expected return. And for that balanced relationship to exist, all crucial factors influencing the risk-taking process should be observable, assessable and calculable.

The reasoning applies to small as well as large scale decisions, investments, entrepreneurial ventures. That is why international economic organisations such as the World Bank and the International Monetary Fund repeatedly advise countries in the global south to install open, transparent, law-ruled political-economic systems to be able to lure foreign investors. An important aspect of that reasoning is that decision-makers need to be able to incorporate all the relevant factors in assessing whether or not to undertake a risk. If relevant factors are left out of the decision framework, this renders the decision-making process faulty - or at best incomplete; as a result, rational investors would shy away.

In the prevailing political and economic environment in the Arab world, a combination of elements results in a severe imbalance between undertaken risk and potential return: the lack of democracy, the absence of the rule of law, the foggy sphere in which politics and economics (especially financing) interplay, and the overarching feeling that the political powers have disproportionate influence over the political and economic game. These significant variables lie in a fuzzy, unclear domain. The future of an entrepreneur's venture is significantly influenced by factors that he or she cannot observe, assess, or calculate, let alone influence. And as such, rational persons - whether a sole entrepreneur with the ambition for a small-sized venture, or a major investment house with the appetite for a major economic undertaking - duly shy away.

Such an environment is frustrating. When a hard-working, visionary entrepreneur undertakes a project, he or she needs to know that the success or failure of his or her venture is a fair game determined largely by his or her talent, expertise, acumen, and hard and soft skills - not by the whims, interests and inclinations of a limited number of individuals controlling generally corrupt systems where the salient success determinants are shrouded with mystery. In almost the whole of the Arab world, on macro and micro levels, such mystery, influential individuals and corruption exist. In game-theory's terminology, the game's solution is to refrain from playing.

A river dried

True, not everybody refrains from playing. New ventures do get started in the Arab world. Actually the last four years have witnessed a significant boom across a number of economic areas, where many new faces took centre- stage, new companies emerged, and new trends were established. However, the vast majority of those new faces, companies and trends were outcomes of a top-down economic system. In many cases, the new generations of extremely well-capitalised families diverged out of the traditional economic spheres of their families into new undertakings, or individuals very close to ruling elites leveraged their connections and access to venture into business.

Also in openDemocracy on Arab economies:

Marcus Noland & Howard Pack, "People power: Arab economies in a global era" (27 June 2007)

Such economic vibrancy, though a value-add in the economy, is not an indication of entrepreneurialism; it does not spread dynamism in the economy, and it does not change the overall dynamics of risk and reward in the Arab world. Such examples actually reinforce the notion that economic success in the Arab world remains, to a large extent, a top-down mathematical distribution

David Landes, in his The Wealth and Poverty of Nations, emphasised the socio-economic danger of the concept of "economic seclusion": societies where the economic life - mainly, asset-ownership and control over money-cycles - is vastly influenced by the top 5% or 10% of the population. There are abundant examples that such societies do not progress into vibrant economies, do not foster entrepreneurialism, do not generate mass wealth, and are very susceptible to socio-economic shocks.

The examples in the book are mainly from Latin America, but the characteristics are highly applicable to almost all Arab societies. Such economic seclusion makes it extremely difficult for the vast majority that is outside the centres of economic influence to engage in meaningful economic activities on a decent scale. This is not only because of its lack of capital or access to funds, but also because of the massive uncertainty that it would undertake if it decided to venture into any entrepreneurial activity. That is why there are economies, such as Egypt for example, with quite high savings but dismal economic vibrancy.

Entrepreneurialism is not only about creating wealth for a small group of business individuals. It is one of the strongest signs of socio-economic participation in a country; it is a sign of commitment; it entails a sense of belonging. And by the same token, the absence of economic participation of millions is a sign of worry - a red flag.

Hafez Ibrahim (1871-1932), a famous Egyptian poet, once described the Nile as a river of duality: gushing with vitality in some locations, dormant and inhabited with sickening worms in others. I am afraid the dominant socio-political scene in the Arab world today, and its impact on Arab vibrancy, is more like the Nile in the latter form.

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