Underdevelopment in the Middle East

Address to the Rotary Club of Central Melbourne

If, 1000 years ago, you had been asked which civilisation would likely dominant the next millennium, Islam would have been a fair bet.

Our best estimates of historical global income suggest that the Middle East was richer than Europe. Islamic trade networks spidered across the world – certainly, much further than the trade networks of Christendom.

Fast forward to 2011, and the Arab world is impoverished, at least compared to the liberal West. The 22 states of the Arab League have an average income less than a third of that of the Western world.

The Arab world is deeply unfree. Its states are almost uniformly illiberal. Its economies are highly regulated, bureaucratic, and its governments are corrupt.

The Arab Spring – the rolling waves of revolts and revolutions which have swept the Middle East since the start of the Tunisian uprising in December last year – should demonstrate clearly the widespread dissatisfaction with this status quo. The citizens of the Arab world want to be free and democratic, and it want to equally successful as the now dominant West.

This raises two questions. How did the Arab world slip so far behind the West on the metrics which we would consider the indicators of social progress – prosperity, liberalism, and democracy?

And does the answer to that question tell us anything about the capacity for the Arab world to catch up – in other words, is whatever held the Middle East back destined to hold it back forever?

The obvious topic here is Islam – both Islam as a religion, and as an organising principle of political economy. Is Arabic underdevelopment Islam’s fault?

No – the fault, according to a comprehensive study by the Turkish institutional economist Timur Kuran, lies not with Islam, per se, but with the development of Islamic law.

A legal system, as we all intuitively know, sets the framework in which capitalist and market development can occur. The laws governing shareholder liability, for instance, or what is allowed in banking, or bankruptcy, can either enhance market efficiency or impede it.

One should be careful interpreting another’s religion for them, but Islam started as a very market-friendly religion.

Mecca was a thriving trading community, a strategic hub between Byzantium and India. It is hard to overestimate how central trade and commerce was to Islam’s theological birth. Muhammad himself was a caravan trader and a business manager. As one historian has written, to ignore the role of commerce and markets in the development of Islam and the life of its founder, is like ignoring the role of oil in contemporary Saudi Arabia.

No wonder then that the Qu’ran is steeped with the din of markets. It defends the institutions of private property, contract law, and profit through trade. “Let there be amoungst you traffic and trade by mutual consent,” speaks one passage. One liberal Muslim scholar argues that the Qu’ran provides a strong foundation for limited government, decentralisation, and restraints on the private sector.

The Islamic pilgrimage was as much a religious event as a commercial one – the Qu’rans call for pilgrimage is followed immediately by this passage “It is no sin for you to seek the bounty of your Lord by trading”, and pilgrims would receive this blessing: “May Allah accept your pilgrimage, condone your sins, and let you find a good market for your wares”. Timur Kuran argues that the pilgrimage to Mecca was the Islamic world’s “leading commercial event” well up until the 19th century.

Islamic society – early Islam at least – was a highly commercial social society. One study suggests that 75 per cent of religious scholars and jurists earned their living from business ventures.

Muslims were among the world’s greatest entrepreneurs and explorers. When the city of Canton on the Chinese coast was captured by bandits in 878 AD, they found 100,000 Middle Eastern traders there. Indeed, the first age of exploration was a Muslim age of exploration.

During the 15th century, Muslim merchants were sailing from Morocco to Southeast Asia, entirely unimpeded. The Western explorers that followed found Muslim communities almost everywhere they went.

So how did such a commercial, entrepreneurial society slip behind the West? Timur Kuran argues that the institutions of Islamic law which had well served it in the first half-dozen centuries failed to encourage and support the forms of capitalist organisation which quickly spread in Europe from the fifteenth century onwards.

While Islamic commercial law was rich and strong nearly two centuries before Europe had even developed its vaunted “law merchant”, it failed to develop as innovatively in the centuries to come.

Indeed, the centuries where Islamic trade was at its height were also the centuries when Europe was experimenting with different institutions for commerce.

For instance, the joint stock company. Islamic law supported a form of incorporation, the partnership. But that partnership was fragile. It could be dissolved at any time, according to the preferences of just one of the partners. And if one of them died. The risk of that partnership obviously increased as the number of partners increased. As a consequence, partnerships were small, and usually temporary. For every new venture – say, for example, a trading mission – partnerships had to be reformed.

Compare this to Europe.

The Medici enterprise was an extraordinary complex, and extraordinarily long-lasting commercial organisation – a series of subsidiary partnerships, inter-city networks, and accounting innovations meant that the Medici enterprise lasted a massive 97 years, from 1397 to 1494. Its model, and the lessons from that model’s management, were replicated widely.

Then the joint stock company, facilitated by changes in European law which smoothed the process of reorganisation as shares were traded. Early join stock companies included the English Levant Company, and the East India Companies – Dutch, French, and English.

The importance of corporate institutional innovation for the development of the European economy has been well-recognised by economic historians. Timur Kuran identifies a number of barriers to the development of the company in Islamic law, for example, polygamy – which, combined with generous inheritance laws, undermined the formation of large amounts of capital. If inheritance only goes to the first born in a monogamous marriage, wealth remains intact. If it is split between numerous children and numerous wives, any wealth formed disappears after a generation.

Islamic law did not encourage new forms of corporate development, but that doesn’t mean Islam is inherently hostile to the corporation. It has been widely embraced from the 19th century onwards. Fundamentalist Islam does not campaign against the shareholder enterprise.

But the Islamic world’s delayed embrace of sophisticated forms of capitalist development have held it back considerably.

And it a brief survey of the contemporary Arab world suggests that it is hardly complete.

The Arab World lacks the economic freedom necessary for prosperity. By economic freedom, I’m going to adopt the classical definition – a political economy where people are free to acquire and use their property as they see fit, as long as they do not impede the identical rights of others.

We can measure economic freedom along a wide range of indices – some direct measures, and some indirect. For example, we can look at relative tax rates, size of government, security of property rights, regulatory impediments to forming business, efficiency of contract enforcement, tariff levels, and so on.

These measures are highly correlated with economic growth, individual prosperity, and a whole host of other beneficial social indicators. Certainly, low levels of economic freedom are closely connected to negative consequences – such as inequality and poverty. This is particularly the case in emerging nations. Economic freedom creates a climate conducive to investment and entrepreneurship, an intuitive argument that has been confirmed empirically, and repeatedly.

The Arab World fills out the bottom ranks on many of measures of economic freedom. This is a substantial backward step from the past – as one Arab scholar has pointed out, in many ways the Arab World was the most open, economically engaged region on the globe for most of its history.

Is culture to blame?

I hope I’ve convinced you that the dominant religion of the region does not have sufficient explanatory power to account for the underdevelopment of the Arab World. Could the problem it be cultural, rather than just religious? It could very well be that centuries of slipping behind the West has encouraged a culture antithetical to the sources of Western success.

Development economists are starting to seriously engage with questions of culture, as it is clear that many of economic history’s greatest questions cannot be answered without recourse to cultural matters.

A paper in the journal of Public Choice earlier this year clarifies that question. It looks at the World Values Survey, the largest and most comprehensive database we have on cultural attitudes around the world.

The paper finds that culture matters – to a degree. While a nation lacks economic freedom, culture is all important. Without formal legal institutions – or when those legal institutions are untrustworthy or unreliably – cultural issues like trust are extremely important.

But the authors of this paper found that as a nation becomes more economically free, the importance of culture declines substantially. The “peace, easy taxes, and tolerable administration of justice” described by Adam Smith is culture-neutral – it does not require, for example, any particular religious belief to function well.

The consequences of this finding for not just Arab development, but also the operation of a pluralistic democracy like Australia, should be obvious.

Let us return now to the Arab Spring, and its relationship to the question of economic freedom and development.

The Arab Spring is above all a democratic revolt. Many in the West have been sceptical about the prospects of Arab democracy because of a fear that the regimes which are elected could be illiberal.

I think this fear is somewhat misplaced, and most certainly unfair. Somewhat misplaced because one of the most striking things about the Arab Spring so far is how Islamist organisations have been united in their call for democratic institutions. This is a substantial change from the past, where revolutionary Islam was more interested in theocratic hierarchy.  We are a long way from the Iranian revolution.

It is worth noting that the loudest proponents of this argument have been the dictatorships themselves – no Middle East autocrat has failed to claim that they’re the only thing holding back the Muslim Brotherhood.

Certainly, it is true that any democracy has embedded in it the risk that it could lead to suboptimal outcomes. We can all name historical examples of democratic failure along those lines.

Yet this is a burden which is unfair to place on societies which are struggling to lift themselves out of tyranny. Yes – revolutions sometimes, even often fail. But that is not a case for the status quo, it is an argument for caution, and a reminder that a tyranny has great costs – including the hollowing out of civil society, the rise of underground extremism, and the political isolation. We cannot rhetorically condemn nations to political servitude if we are weary about the consequences of them escaping that servitude.

Let me raise a serious objection to my argument for economic freedom in the Middle East.

Nevertheless, some have claimed that the Arab spring is a revolt against not just tyranny, but economic liberalisation.

They have some evidence in their favour. Egypt has been liberalising substantially over the last decade. From holding a place at the bottom of the Economic Freedom in the Arab World report, it now occupies the middle. It reduced its average tariffs from 15 percent to just 5 percent. It dramatically lowered the corporate tax rate from 40 percent to 20 percent. Its maximum personal tax rate is now a tiny 20 per cent. It has privatised entire swathes of its government run corporations.

This was a successful program of liberalisation, economically. The average growth rate in Egypt increased from 3 per cent per year around the turn of the millennium to 7 per cent. Unemployment declined from 12 per cent to 9 per cent.

Egypt is still poor. But now it is less poor, and on a trajectory to becoming rich.

Nevertheless, with liberalisation comes great disruption. We know this from our experience in Australia. There was a great sense that this liberalisation was being imposed – as, indeed, it was – by a corrupt and self-serving government. The privatisations have been dogged by secrecy and constant allegations of corruption.

After all, the purpose of privatisation is not simply to sell off assets, it is to introduce market dynamics and competition into industries which have stagnated under government ownership. Consumers, not oligarchs, are the intended beneficiaries of privatisation. Under that criteria, much of Egypt’s privatisations have performed poorly.

Combined with a general view that the government is irredeemably corrupt – from the absolute top of the state apparatus to the bottom, at the level of the local police stations – the potential for revolution in Egypt has been long recognised.

I have argued that the Egyptian revolt against Mubarak helps illuminate one of the great chicken-and-egg questions – which comes first, political freedom or liberalism? The Egyptian example suggests you cannot have one without the other – they must develop together. A tyranny that imposes economic liberalisation will be resented.

Dictators can’t always have it both ways. They can’t reap the benefits of economic growth – their higher tax revenues and more luxuries to hand to political supporters – and maintain complete political control at the same time. No country can be both a police state and a market paradise.

An increase in GDP is no comfort for someone who has been tortured in custody just to fill an arrest quota.

So the push for economic freedom in the Arab world cannot be separated from the push for democracy and liberalism.

Fortunately, we don’t have to impose our own Western values for this to be successful.

They may be rarely spoken of, but Islam has had its fair share of liberal thinkers. I’ll highlight just one.

Khayr al-Din was a Tunisian statesman and author in the 19th century. He travelled widely in Europe, and his investigations there informed his 1867 treatise The Road Most Straight to Know the Conditions of the State.

In this book he reports back to his national compatriots what he understands to be the strengths of the West – in awe of Europe’s military and economic power, nineteenth century Arab nationalists and liberals sought ways to emulate, and eventually, surpass the West.

It wasn’t Christianity, Khayr al-Din argued, that made the West strong, otherwise the Holy See would be the most advanced state in Europe.

Instead, he argued it was Europe’s “political institutions based on justice and freedom” – its low taxes, growing democracy and antipathy to despotism. He argued for freedom of the press, freedom of association, and freedom of participation in government.

Rulers might be beneficent and omniscient, but it was best to assume that they were not. The source of their legitimacy was a fundamental power higher than they – justice. Rulers must be therefore constrained by the rule of law.

And he justified all these arguments on Islamic terms, by reference to the Qur’an.

If the Arab World is going to be rich, it will need to take the advice of Khayr al-Din.