Why Have The Islamic Countries Failed To Develop?

It’s true. Outside of oil and gas projects and a few specific infrastructure projects (ports like Jebel Ali and airports like Dubai), far less real economic development has happened in the oil-rich parts of the Arab world than would be expected based on their great endowment of human and natural resources. The Islamic world isn’t monolithic, and it’s probably worthwhile to address relatively stable oil-rich states separately from Iraq, Iran, and Libya, again separately from other Islamic states without much oil separately from Asian Islamic countries like Malaysia and Indonesia. Let’s look specifically at the stable oil rich Arab Islamic states for now. I’m not an academic economist, political scientist, or cultural expert, but I lived in the region from 2004-2010, ran several businesses there, and have experience as a tech entrepreneur in the US and Europe, so I can comment directly on some of the challenges.

(There are some really interesting aspects of Iran, Pakistan, Egypt, Malaysia, and Indonesia which would be interesting to address separately — they demonstrate what happens when some of these trends are reversed and taken too far the other way. Those countries deserve another question.)

Overall, the local standard of living has improved dramatically — walking around Dubai or even a moderately sized city anywhere in the region shows a reasonable standard of living, especially compared to a few decades ago. All those shiny new condo buildings, huge hypermarkets, highways, etc.

However, it’s all consumption of energy wealth, not evidence of other productive economic activity. While the economic theory of comparative advantage says you maximize efficiency by going all-in on areas where you have the greatest comparative advantage, economic efficiency isn’t the ultimate goal of life, and there are serious consequences to blindly maximizing current economic efficiency to the exclusion of all else. There is a huge qualitative difference between an economy built on natural resource extraction, where the populace is a cost center, and an economy built on productive labor by the population, where increasing capabilities of the society leads to more wealth. If you look at western countries, Japan, Taiwan, Korea, and increasingly, China, they largely developed through manufacturing, initially low cost, low value add manufacturing, moving up the chain, and ended up with vibrant, well-educated, and diverse economies (even though Japan has demographic challenges, it will still be the #3 economy in the world in 2030). The alternative is an extractive economy like Argentina, which went from 10th in the world in 1930 to a basketcase for the past 80 years. That’s not to say that natural resource endowment hasn’t helped some countries (like the US), but natural resource economies in the absence of local value creation don’t tend to lead to well developed societies.

Wealth in a resource-based economy is distributed much more unequally and more inefficiently. It goes to a small number of people at the top, and they’re at the top due to tribal, family, or political connections, not due to skill or productivity. In a vibrant, competitive manufacturing economy, wealth tends to accrue to innovators and efficient operators, and someone with a new idea or better way of doing things has a chance to get to the top.  Admittedly, this is imperfect even in the US, but it’s a better system than political patronage.

And, someday, the oil will run out (or won’t be burned because of global warming).

Outside simple products and services for local consumption (consumers spending income directly from energy related jobs, or from government redistribution of energy wealth), and development, funded by energy wealth, of local transportation, power, and water infrastructure (starting from a very low base), what local development there has happened has been economically inefficient — building empty skyscrapers in the desert. This has been largely directed by government, or influential families affiliated with government, and financed by huge capital flows from oil/gas and foreign investment from Russia, South Asia, and other parts of the Arab or Muslim world, and not the product of real free enterprise. Essentially, these investments don’t produce wealth; they’re just a way to store wealth generated elsewhere, as a form of regulatory arbitrage. Even crazier, most of the labor, including skilled labor, to build buildings and operate companies is imported, too — labor from China and Pakistan, accountants from the Philippines, advertising executives from the Levant, and engineers and architects from the UK and US.

Placing oil and gas revenue into sovereign wealth funds (SWFs) which invest in businesses in the west has generally been the other form of investment, and in spite of the western financial collapse of 2008-2009, major Islamic SWFs still make most of their investments outside the region.

There are a few likely reasons energy wealth hasn’t been sufficient to push these countries toward greater and more robust development:

• Fundamentally, this is a push against the economic efficiency gradient. It will not happen without serious effort and luck, at least until energy income declines.
• A historical legacy of a Soviet alliance and socialism in the Arab world (due to their opposition to the west during the early cold war, opposition to Israel, and some ties between Pan-Arab nationalism and socialism just due to both being revolutionary anti-colonial movements, and due to the beliefs of specific leaders like Nasser).
• Resource curse (“Dutch Disease”). Essentially anyone smart goes into oil/gas, or if smart/lazy, into oil/gas ministry jobs, and anyone seeking safe investment returns tends to invest in oil/gas, where a great return is likely. Having some resources is better than no resources, but having resource based industries dominate your economy crowds out all other investment.
• Anti-intellectualism and anti-science bias of modern fundamentalist Islam. Clearly it’s not the case that Islam itself is hostile to science; after all, for hundreds of years, the Islamic world was the standard-bearer for world scientific knowledge and progress. Yet, education in many Muslim countries consists primarily of religious rather than scientific programs, and those who do get quality educations in the west tend to remain overseas.
• Women as second-class citizens. It’s not just that women can’t contribute directly to the workforce (although that’s a big factor), but that women aren’t educated to the same standard, and thus aren’t able to raise children to be scientists and engineers as effectively. This is one area where great progress has been made, but there’s a generational lag.
• Geopolitical instability. In general, lack of stability doesn’t lead people to make long-term investments in the future. If you’re worried the world is going to end, you’re going to enjoy life now (to the extent possible), not sacrifice a lot to potentially have a better future. A high level of fatalism and lack of feeling of agency has never helped entrepreneurship.
• Antiquated legal environment (largely based on old UK law without update, merged with Sharia), and not really compatible with modern business. Setting up a business takes a long time, requires local partners, etc. – not a free market. There are efforts to have different law for some countries (the Dubai free trade zones are great examples — Jebel Ali in the 70s was probably the first major development of its kind), but the law outside business still needs revision.
• Corruption. It’s a combination of an inefficient official process and a small number of wealthy and powerful families, able to either change the law as needed, or ignore it. If you ever get into a dispute with a local national, you’re going to lose. If local nationals of different levels of power (“wasta”) get into a dispute, it’s usually decided on the basis of connections, vs. the merits of the case.
• High cost of failure. If someone launches a new business and it fails, there’s a high degree of shame and loss of social standing, but even worse, potential prison time for any debts personally guaranteed. Compare this to Silicon Valley where an entrepreneur with a few failed businesses is generally viewed as experienced.

(I’d also argue that their hostility to Israel – and thus Jews – actually hurts them a lot, as some of the most dynamic tech and business people in the US are Jewish — they and their firms are unlikely to do business where they’re not welcome.)

It’s especially interesting what is NOT on this list.  Islam is certainly not inherently opposed to development and progress — there’s the shining example of the classical period of Islamic civilization, and the huge number of successful Muslim scientists, engineers, entrepreneurs, and business people in the US, Europe, and elsewhere.  Democracy also isn’t on the list — we have great examples of non-democratic economic successes (China, and if you extend to one-party democracy, Singapore), and of democratic non-successes (India pre-1990s).

Essentially, no great companies have been built in the region (yet), except to serve local consumption of wealth derived from energy.

There are a few potential exceptions — the media company Al Jazeera in Qatar is probably the best example. It’s unclear how profitable Al Jazeera is, but it’s undeniably consequential globally — one of the most important media companies in the world. Emirates Airlines has been very successful, in the model of Singapore Airlines, and there are several other airlines which have been successful to different degrees. Both of these were state sponsored at the beginning. For really private businesses, PwC/Agility logistics (which, admittedly, was largely built on the back of the US occupation of Iraq and artificially inflated prices and demand for shipping), and a little farther afield, Jordan’s Aramax courier company is interesting (although not an oil state).

There are of course construction (Orascom) and communications (Wataniya) companies which are regionally important, making investments in Asia and Africa. There are some agricultural, retail, and distribution brands which serve the local economy, but aren’t really great engines of wealth.

The irony is that while real growth should originate from and be sustained by the private sector, it’s undeniable that some of the enlightened governments of the Gulf (particularly Qatar, Dubai, Jordan, Oman and to some extent, Bahrain, Saudi Arabia, and other UAE emirates) are more progressive and pro-growth than their populace. So, there’s probably a necessary government role in starting the process, but the state needs to get out of the way after giving an initial push.

I think the most promising efforts are bringing top universities from around the world to the region, and establishing new schools like KAUST, which will be both centers of research and product lots of well educated people. Yet, from looking at the students enrolled today, many are from outside the region (mainly, SE Europe) — local nationals are more likely to go overseas for an education, or to take a ministry, banking, or other safe, well-paid job fed by energy wealth vs. starting a high risk new business.

Ultimately, investment by government can only provide a foundation for private development.  Building infrastructure (physical, legal, and educational/human capital) with oil wealth, until the oil wealth runs dry (solving the resource curse) so the best and brightest then go start productive businesses, is probably the solution, but could take decades. On the other hand, if you look at where the Arab world was fifty years ago, and where it is today, there’s good reason to be optimistic about the future.

http://www.forbes.com/sites/quora/2013/01/08/why-have-the-islamic-c...