Throughout 2011, youth from across the Arab world have occupied streets, squares and other public places to protest a lack of inclusion, a lack of dignity and a lack of social justice. The most cited cause uniting the protesters is a desire for inclusion in the process of governance, primarily as a means to address these concerns. 

But underlying this cause is the lack of inclusion in the economy. Unemployment is the biggest security threat facing the Arab World today. In some Arab countries, the proportion of those under the age of 26 and out of work is as high as 25%, one of the highest youth unemployment rates in the world. The economic loss arising from youth unemployment exceeds $40–50 billion annually across the Arab world, equivalent to the GDP of countries such as Tunisia or Lebanon. 

Although this may seem bad enough, the real issue facing the region is that the future looks much bleaker. Taking the United Nations Development Program’s (UNDP) assessment in 2009 that 51 million new jobs must be created by the end of 2020 merely to stand still on unemployment, at face value, we see that the Arab countries must, in effect, increase the number of employment positions in the region by around 50% over the 10 years to 2020.

Looked at another way, from the same UNDP report, we would need to grow our economies at an annual rate of 7.6%, to generate the requisite employment opportunities. This, just for unemployment not to get worse. And indeed our economies are growing at much lower rates these days. For countries without large fiscal surpluses, that is both a massive challenge and an even more massive liability if they fall short. For countries with significant fiscal surpluses there will be no real escape in the final analysis. The cost will inevitably need to be passed on and the cost will be huge. The entire Arab world faces being engulfed by the impact of rapidly rising unemployment.

How to avoid these scenarios and create the necessary economic and employment growth? Investment and related reform is the only solution. Investment is required in infrastructure, in education and directly into private sector enterprise. It is estimated from studies in the U.S. that every billion dollars of investment in infrastructure can create 18,000 direct and downstream jobs. Investment in ports, airports, financial centers and industrial zones are good examples.

Yet faced with the magnitude and urgency of the task, infrastructure investing is but a relatively small part of the solution. Nor is employment by the state going to provide a solution. Put simply, there aren’t any more jobs to give out and what more jobs can be manufactured will not be sustainable in the long term. Employment on a mass scale needs to be delivered by sustainable private sector economic growth and for that we need to invest heavily in the private sector and educate our youth to be able to fill the private sector jobs that are then generated.

How to invest in the private sector? First, focus on SMEs. According to EU research, an investment in an SME is twice as likely to create employment opportunities as an equivalent investment in a large corporate. Similarly, research from the US shows that between 1980 and 2005, the U.S. economy created 40 million net new jobs, from businesses that were less than 5 years old. SMEs are also more likely to create employment in newer more innovative sectors, thus providing economic diversification and knowledge economy jobs.

Second, invest through the private sector. Government funds destined for the private sector should be given to private sector investors. Only the private sector has the true motive to invest sustainably; it is an existential requirement for private sector investors to make financially viable investments. Moreover, private sector investors can take whatever government funds they are awarded and leverage them with other capital they can raise. A proven model is that of the Enterprise Funds in Eastern Europe and Russia, which were financed by government funds and managed by independent private sector boards. Between 1990 and 2006, these funds dispersed $1.2 billion into 500 SMEs and have been estimated to create 250,000 jobs. The funds also made profits for the governments that invested. 

To date, the amount of investment in SMEs that is happening in the Arab world is a tiny fraction of what is required. Banks are not lending. According to recent research, SME lending accounted for a mere 8% of all lending in the MENA region and a mere 2% in the GCC. This is despite the fact that SMEs account for more than 90% of all enterprises and employ perhaps 70-80% of the workforce.

But blame cannot simply be cast at the banks. To be fair, the vast majority of SMEs are simply not bankable. Banks have relatively little to gain from any individual loan and relatively much to lose if it goes wrong. They are faced with arcane or non-existent creditor rights on the one hand and informally arranged counterparties as borrowers on the other.

What is needed, in addition to wholesale reform of laws regulating creditor rights, is a form of finance that matches the risks and rewards of investing in an SME. That means equity. Aside from the matching of risk and reward, the advantage that equity has is that the equity investor has a vested interest in converting the company into a more viable, investable and, in due course, bankable or sellable enterprise. Equity, and professionally managed private equity in particular, is the ideal change agent for the region’s SMEs. Its capital is put to work creating economic growth and job creation and its managers’ focus on bringing about positive changes in governance, putting in place systems and controls that will make the company investible, bankable and sellable.

The profits made through successful equity investing are then available to be re-invested in larger quantities. This is the lesson of equity investing in places like the United States, Europe, China and India, where the quantum of equity available for new and growing enterprises is on a scale simply unimaginable in our region.

To date, despite its proven ability as a change agent for economic growth and employment creation, there are but a small number of active equity investment programs in the Arab World totaling a few hundred million dollars, with the ability of impacting perhaps a few hundred companies rather than the tens of thousands that need to be impacted. Regional sovereign wealth funds have not, as yet, brought their considerable resources to bear.

In fact, the challenge seems to have been most actively taken up by international developmental finance institutions (DFIs) such as OPIC, the IFC and the European Investment Bank, and by developmental agencies from individual European countries. Their approach has been to commit capital to established private equity fund managers or directly into companies and thereby to mobilize private capital that can be raised alongside them. It is a proven technique and one that provides double or even triple bottom line benefits including developmental impact such as job creation, improved environmental, social and governance-based (ESG) change and profit. The fact that these funds generate private equity level profits makes the whole scheme financially and economically sustainable. Investors will come back again and again and a virtuous cycle of increasing investment commences. It is not aid. It is sustainable investment. 

Yet despite the proven model, the amount of money deployed in this manner remains insignificant relative to the need. One challenge appears to be that capital is pledged but then not actually deployed and one of the issues is that the process of allocating capital is inefficient. The times between announcements of programs and disbursement are notoriously long, often running into years. Conditions are often attached to allocations that make deployment difficult or perhaps even impossible. More money needs to flow and we need to make that process more efficient.

Looking at the scale of the issue through another lens, a recent survey by the IFC and McKinsey & Co estimated that the MENA region is home to some 2.3 million SMEs and that their unfunded capital requirements run to the tune of US$140 billion. Much less than 1% of this requirement has to date been deployed through private equity programs.

Capital is by far the major lubricant of economic growth and related employment growth but its absence is not the only friction that SMEs face. They also need access to best practice and access to markets. On one hand, best practice, whether in the form of human talent, good corporate governance or sophisticated business techniques is increasingly available in the Arab World. A generation of skilled entrepreneurs and business managers is indeed present and motivated, with business founders driven largely by the need for economic self-determination. And knowledge sharing of all types has increased dramatically in line with communication and technology advances.

On the other hand, the education system is not yet producing the right kinds of graduates in all the right places. So, whilst access to education in the Arab World has been successfully broadened, we find that many graduates do not have the right skill sets for the jobs that are out there. This is reflected in the aspirations of graduates, a significant proportion of who would prefer a comfortable public sector job to one in the private sector. Vocational training programs need to be created through public-private-partnerships. We cannot afford for education to be an end in itself.

As for access to markets, this is perhaps the major friction after access to capital. It is no coincidence that the EU, US, Chinese and Japanese economies are the World’s largest or that India, Russia and Brazil are not far behind. They all have huge internal markets. And they all attract vast amounts of capital for investment as a result.

If you compare the Arab World, we have relatively small fragmented markets. Even Saudi Arabia and Egypt are tiny markets compared with an India or a China. Our internal borders should be designed to attract capital, people, trade and ideas from within the Arab World whereas in practice there are significant frictions and barriers. Yet only if we unlock the consuming power of the 350m Arabs who live within these various borders will we be able to offer our growth businesses the opportunity to become regional and international powerhouses with the ability to soak up the millions of new entrants into the job market that are coming every year. That opportunity theoretically exists if we can establish economic integration within the Arab World. 

This would mean relaxing customs regulations and encouraging cross-border trade and movement of people, goods and ideas. Think of the investment that will flow if that happens. There needs to be an Arab economic union similar to the single market created by the European Union or perhaps just greater economic union around existing political groupings such as the GCC. The fact that the monetary union of the euro-zone is under so much stress right now does not detract from the unquestionable economic success of the single market of the full EU. Monetary union is a separate and unnecessary step for the Arab World.

These frictions to growth in the private sector are addressable; they have been addressed in other economies before. Yet, in the absence of the sort of coordinated stimulus to the SME segment that is outlined above, the region’s hopes for pulling out of its unemployment trap are slim just as the potential liabilities of failing to act are vast. The youth of the Arab Spring came out on the streets demanding inclusive prosperity and economic empowerment. The time for planning and announcements is way past now and nothing less than an immediate and massive fiscal stimulus into the region’s economies, via the private sector, will prevent even greater disaffection on the streets.

[photo from UN Radio]