Electronic copy available at: http://ssrn.com/abstract=1324570

 

1 

 

Is Governance a Prerequisite for Democracy? Insights from the Middle East

Dr. Assem Safieddine *1 As57@aub.edu.lb

American University of Beirut Director of Corporate Governance Program

Leila Attoue MBA Student

Lma08@aub.edu.lb American University of Beirut

Democracy in the Middle East has been in the spotlight of the world media for a number of

years now. Along with the ever growing international debate on the importance of democratizing

political systems around the globe, questions such as how seriously the Arab countries take the

calls to adopt real democratic practices and how far they have gone in implementing political

reforms continue to arise. While some signs of change have apparently emerged, these questions

remain difficult to answer, even for practitioners in the field.

In a broad sense, democratic societies are defined by the adoption of political practices

such as public debate, expression, freedom of speech, elections, representation, transparency and

accountability, as well as consensus building and active decision making. However, a broader

definition of democracy also encompasses attributes of economic democracy such as economic

justice, property rights, freedom of contract, broad access to information and education and

poverty reduction (Norris, 1999). This view is strengthened by the correlation between political

democracy, economic freedom, governance, and the private sphere. In fact, it is said that the

institutionalization of economic reform and corporate governance around the world is one of the

fundamental challenges of promoting democracy and economic stability. A link has also been

identified between democracy and economic growth, especially when proper governance

mechanisms are prevalent (Doucouliagos and Ulubasoglu, 2008; Rivera-Batiz, 2002).

                                                            1 Corresponding Author

Electronic copy available at: http://ssrn.com/abstract=1324570

 

2 

 

Focusing on the economic, financial market development and governance aspects of these

issues, this paper further explores and endeavors to identify and shed light on some of the

reforms being introduced in the region that are expected to pave the way to deeper democratic

reforms. In particular, the paper attempts to answer the following questions: (1) What types of

reforms are being undertaken?; (2) How do these reforms relate to democratization?; and (3)

How would they eventually trigger the need for reforms at the political level?

The answers to these questions take into consideration that the transition to democracy is

not easy or fast and that the road chosen to introduce and implement democratic and political

reform varies across countries. However, certain prerequisites, such as a strong will at the

authority level and awareness of the need for and the importance of such reforms at both the

ruling and public levels, remain the common ground for any move in this direction anywhere in

the world. The commitment of politicians and policymakers, the motivation of government

employees, the introduction of entrepreneurship and dynamism by profit-seeking risk takers and

the implementation of a democratic process for citizens are crucial for reform implementation

(Laurila and Singh, 2000).

In fact, a closer look at the Arab countries suggests that many of their ruling elite show a

will to forego some of their power over economic interests and encourage the participation of the

private sector and citizens in the process of wealth creation, consequently alleviating poverty

problems. This is being progressively achieved through both the privatization programs that are

currently in progress in a number of the Arab countries and the continuous development of the

region’s financial markets.

The countries of the region also seem eager to liberalize and expand their economies and

markets and attract international capital flows. As much as these markets appeal to international

investors, the achievement of these ends and the ability to sustain them place regulators under

pressure to establish well-governed financial markets. Consequently, a culture of sound

corporate governance, where shareholders ensure that they are treated equally, their rights are

respected, their best interests are pursued by directors and managers and transparency and

disclosure rules are imposed, will gradually emerge among all market participants. Citizens will

come to realize that their rights as shareholders in companies are to a large extent equivalent to

 

3 

 

their rights as nationals in their countries. This is in line with Gompers, Ishii, and Metrick’s

(2003) description of companies as republics where the rights of shareholders mirror those of

citizens in their nations and where the fiduciary duties of boards of directors and managers,

respectively, resemble to a great extent those of parliamentary members and ministers. Thus,

citizens will learn to adopt an active, rather than a passive, role in their countries. Consequently,

an awareness of democratic practices will become prevalent among the communities of the Arab

countries. These include the right to elect representatives who are accountable for acting

according to the will of the people and responsible for delegating decisions to ministers and

examining the performance of the government. In reference to Gompers, Ishii and Metrick’s

(2003) argument, an environment in which citizens have the power to hold ministers and

governmental authorities accountable and to replace them when necessary is regarded as a

democracy. In such a setting, citizens would also press to be allowed to express their opinions

freely; have access to transparent information on the activities of the authorities, the government

and the public institutions; and impose disciplinary actions on corrupt behaviors. In the Gulf

Cooperation Council (GCC) countries, improvements at the public level have already started to

take effect. According to the World Bank, regulatory quality and control of corruption are two

aspects of public governance that have particularly improved. Over the past decade (1996-2006),

the two measures respectively increased from averages of 0.44 and 0.11 to averages of 0.54 and

0.69 for the GCC countries (Kaufmann, Kraay and Mastruzzi, 2007).

The paper is organized as follows: the next section starts by presenting the factors that

have slowed the transition to more democratic regimes in the Middle East; section III sheds light

on the political reforms undertaken in the recent past. Section IV provides insights into the drive

towards economic reform and financial market development and presents arguments on the

relation between these moves and democratic change, while section V focuses on the impact of

liberalization and corporate governance. In section VI, we present arguments on the need to

introduce democratic reforms in order to sustain economic growth, and section VII concludes the

paper.

FACTORS THAT HAVE BEEN HINDERING DEMOCRACY

 

4 

 

An overwhelming majority of Arab countries have been lagging behind in the practice of

democracy; the slow drive to democratic restructuring has been attributed to many factors.

Countries within the region were believed to be resistant to democratic reforms and to have little

hope of moving toward democracy because they lacked the required democratic experience.

Kedourie (1994) states that the institution of constitutional rule in the region is hindered by the

fact that the people are accustomed to “autocracy and passive obedience”. To Cantori (2002), the

region is characterized by narrow political and economic power interests and by a political

succession of power that is far from being a political transition. Deegan (1993) considers that the

countries of the Middle East are “weak institutionally; divided ethnically; tethered to

authoritarian structures of government; lacking in unity, political legitimacy and tolerance of

opposition”. Furthermore, Richards (2005) claims that the low dependence of these countries on

their communities and the sufficient resources available to the authoritarian governments have

undermined the incentives for reform and hindered the transition to democracy.

In addition to serious social problems such as unemployment and poverty, Richards (2003)

cites the lack of accountable governance structures and corruption as key detriments to

democracy in the region. These factors reflect the close ties between democracy, governance and

anti-corruption. Marquette (2001) notes that good governance, or good government, is equivalent

to democratic government. The relationship between governance and democracy is also revealed

in Leftwich’s (1993) definition of good governance as including “some or all of the following

features: an efficient public service; an independent judicial system and legal framework to

enforce contracts; the accountable administration of public funds; an independent public auditor,

responsible to a representative legislature; respect for the law and human rights at all levels of

government; a pluralistic institutional structure, and a free press”. Corruption, on the other hand,

is defined as the abuse of power resulting in the reaping of benefits at the expense of the rights of

an individual, group or the whole society; the making of public institutions controlled by private

interests; and the hindering of the transparency of governmental operations (Wei, 2000).

Denoeux (2007) reports that the high levels of corruption in Morocco have long been caused by

the concentration of wealth and economic power, the meager scrutiny of public affairs and

dealings and the favoring of officials and entrepreneurs who hold close ties with the monarchy in

terms of unfair advantages and non-transparent business transactions.

 

5 

 

SIGNS OF POLITICAL CHANGE

In 1998, Kamrava argued that democratic governance in the Middle East is hard to attain

because the necessary grounds of social and cultural dynamics do not exist. Yet, since then,

several events have occurred, and many circumstances have been transformed, gradually shaping

a picture of the region as open to reform and planting roots of hope for democratic change. While

Richards (2005) agrees that a “democracy deficit” is a prevailing fact in the region, he does not

agree that the Arab countries are “not ready” for democracy reform, and he identifies sound

grounds for a potential shift towards more accountable and democratic governance. Those

include the current level of development, literacy, education and urbanization. For instance, the

World Bank indicators of 2007 reveal that enrolment at secondary schools in the Middle East

and North Africa (MENA) region increased from 67.7% in 2000 to 73.5% in 2005. In Morocco,

the rate increased from 38.1% in 2000 to 52.4% in 2006. Qatar recorded a 100% enrolment in

secondary schools in 2006, up from 87.6% in 2000. In 2003, 97.5% of males and 94.5% of

females were enrolled in primary schools in Saudi Arabia, as compared to 61% and 57%,

respectively, in the period 1994-2000. Richards (2005) concludes that democracy is attainable

provided that some political obstacles are overcome.

For a political reform to be introduced and instituted, a strong will at the authority level

must exist. In addition, in countries where the level of corruption seems to be advanced, building

awareness in the public and in all institutions and corporations seems to be an essential step in

the democratization process. Arab countries have already started to reveal some desire to

introduce reforms, and some steps undertaken are expected to contribute to raising public

awareness. While several countries in the region have embarked on instituting anti-corruption

and democratic reforms, the speed and level of their achievements vary.

We have begun to notice the gradual shift of the region’s governments towards running

and boosting the participation of their populations in more free elections, and we now hear the

voices of some forces opposed to the regimes in place. Algeria held its first elections in 1999,

and for the first time, in 2002, Qatar allowed its citizenry, including women, to participate in

direct and secret voting (Isakhan, 2007). Kuwait is considered the GCC country that has

 

6 

 

witnessed the greatest political change towards a civil society and away from the ruling elite, as

demonstrated by the elections of summer 2006 (Ehteshami and Wright, 2007).

In 2000, a political reform strategy was formulated in Bahrain specifying a framework for

establishing a constitutionally grounded political system (Ehteshami and Wright, 2007).

Morocco has also made some progress in its attempts to fight corruption. Transparency-related

matters have been improved, and the upgrading of the country's legal and regulatory framework

is now underway. Some non-governmental institutions (NGOs) have been working on building

awareness among the public and lobbying the authorities. Still, Denoeux (2007) states that much

remains to be done in terms of enforcing the laws and imposing accountability.

ECONOMIC REFORM AND FINANCIAL MARKETS’ DEVELOPMENT: A STEP

TOWARDS POLITICAL REFORM

Nevertheless, Doucouliagos and Ulubasoglu (2008) assert that political democracy is more

than free elections, and they report that previous evidence suggests that political democracy is

correlated with economic freedom, governance and the private sphere in the economy. These

aspects, among others, are particularly emphasized by the Arab countries. In fact, the majority of

the Arab countries, notably the GCC countries, seem to have chosen to approach reform from

another angle: the economic angle.

While Richards (2005) contends that the surge in oil prices would strengthen authoritarian

rule in the region because the ample resources would hinder incentives for reforms, Hertog

(2007) claims that the boom is “generating a new regional political economy” where business

and Foreign Direct Investments (FDI) are playing ground-breaking roles and the Gulf is a

“pivotal player”. In fact, the GCC countries seem to recognize the benefits that could be

extracted from the oil boom and are taking advantage of the increased liquidity in their markets

to institute economic and market reforms. To Hertog (2007), the current boom is better managed

than the one that occurred in the 1970s; less money is wasted, and more is being invested in

projects and utilized in sophisticated and diversified ways. The transformations and

developments currently being observed in the Gulf financial markets are indeed unprecedented.

 

7 

 

Along with Dubai, Qatar, Bahrain, and even Saudi Arabia are putting substantial effort into

creating special zones, administrations and economic cities to attract and retain capital. In a

move towards liberalizing its markets, Saudi Arabia has finally entered the World Trade

Organization (WTO). This accession would facilitate its shift towards a more open and balanced

economy because it requires the introduction of structural changes to the economic and legal

regimes, the institutionalization of reforms in public institutions and a commitment to economic

diversification and privatization. A Credit Suisse report (2007) noted that Saudi Arabia has

already created nine regulatory bodies and announced a complete overhaul of its judicial system.

Additional benefits also include reducing bureaucracy, addressing issues relating to the opacity

of decision making, safeguarding access to Saudi markets and greatly enhancing protection of

intellectual property rights, along with the adoption of enforcement procedures and the

imposition of penalties for violations. Saudi industries were also expected to benefit from

increased transparency and access to important information relating to governmental and legal

procedures. As the law firm Loeffler Tuggey Pauerstein Rosenthal LLP stated in its summary

report (2006), together, these initiatives “will increase transparency and predictability, which

serve as a basis of the global economy”. Such initiatives would no doubt serve as preliminary

anti-corruption procedures.

Privatization programs of public institutions, such as telecommunications, water and

energy supplies, banking and insurance, are also gaining increased momentum across the

countries of the region. For instance, in an attempt to diversify its economy, Bahrain is

implementing a privatization scheme through the Supreme Privatization Council. Abu Dhabi has

also taken steps towards privatizing utilities. Furthermore, a report by Kamco Research (2007)

notes that the Capital Market Authority of Muscat Securities Exchange has recently presented a

“golden share” method whereby state-owned, strategically important companies are encouraged

to divest stakes for public investing while giving the government veto power even in cases where

it is a minority shareholder.

These privatization efforts aim to encourage wider participation of the private sector in the

economy. Hertog (2007) states that the private sector is in fact becoming more and more

independent from state contracts and is playing a greater role, with private wealth in the Middle

 

8 

 

East being estimated at $1.5 trillion. The heightened participation of national citizens in the

economy, and in the financial markets in particular, is notable. Gulf investors have begun to

move from being rentiers to entrepreneurs who take active interests in projects and establish

start-ups (Hertog, 2007). These initiatives were encouraged as the bureaucratic procedures to

start a business were alleviated in several Arab countries. Egypt, for instance, was identified as

the top reformer of 2006/2007 by the World Bank’s “Doing Business 2008” report. Saudi Arabia

was among the top ten reformers and was ranked 23rd out of 178 countries in 2007 on the ease of

doing business.

Entrepreneurs in the region were motivated to offer their companies for public subscription

through more liberal listing rules related to the pricing of the offer or the reduction of the

minimum percentage stake of the offerings. This process has resulted in IPO euphoria in the past

few years. The total amount raised from IPOs in the GCC increased by 40% between 2006 and

2007, and a great potential for more is still expected (Shuaa Capital, 2008).

By expanding privatization programs for inefficient public companies and enabling a large

number of companies to raise capital through the financial markets, the countries of the region

have provided further support for their stock markets. Also fueled by the excess liquidity, the

region’s stock markets have witnessed a long-lasting upward trend. With more than $700 billion

in market capitalization, the Saudi stock market is expected to exceed South Korea's and

approach India’s exchange (Hakim, 2008).

In summary, while some changes started to occur due to political pressures from the U.S.,

others were motivated by and came into existence after observation of the “Dubai” Model, which

succeeded in opening that economy and establishing it as a dynamic and fast-growing hub in the

region. The aim of this paper is not to build hopes for major democratic transformations that are

not likely to be achievable or may be constrained by the inherent factors of the Arab countries.

However, on a smaller scale of expectations, some political reforms driven by the observed

economic reforms can be hoped for. We are thus arguing that financial markets’ reforms will

reinforce the transition towards more democratic governance. The link between these reforms

and democracy stems from two important factors and reveals a certain level of willingness

among the ruling elites for change. First, the drive to privatization implies that the ruling

 

9 

 

authorities are willing to give away some of their powers or control over economic interests.

Second, a reduction of poverty levels and a more equitable distribution of wealth among citizens

are being achieved. The emphasis on the private sector and the fast development of the capital

markets are leading to wider participation by citizens in the wealth creation of their countries.

According to the United Nations Development Programme (UNDP), Bahrain has undertaken

serious improvements in alleviating poverty and fostering democratic governance. Based on the

indicator that measures the number of people living on less than US$ 1 per day, Bahrain does

not suffer from extreme poverty. In the same way, Kuwait has achieved tremendous progress in

eradicating extreme poverty and hunger. In 2005, the average expenditure of the Kuwaiti poor

was ten times higher than the international poverty line of $1.08 per day.

In Saudi Arabia, the boom of the Saudi stock market has been shared by a large proportion

of the population and has helped generate wealth for millions of Saudi investors, creating a

middle class in the country (Ehteshami and Wright, 2007, Hakim, 2008). The Kingdom has

already succeeded in cutting poverty levels by half, a major step towards achieving the goal, set

with the UNDP, of eliminating poverty by 2015 (Al Hakeem, 2007). The Saudi IPO

oversubscription rates of 10 or 12 times are in fact illustrations of the high participation of the

population in wealth creation. The IPO of the petrochemical company, Yansab, attracted more

than a third of Saudi Arabia’s population of 17 million according to the country’s finance

minister. Because they have reduced poverty levels, these developments are considered a key

component of democracy, in line with Bhagwati’s (1982) and Krueger’s (1974) view that

democratic governments have to remain alert for redistribution to lower-income groups.

LIBERALIZATION OF FINANCIAL MARKETS AND CORPORATE GOVERNANCE

Other market reforms were noticed, as many of the region’s countries share a vision of

establishing leading international financial markets and attracting local and international capital.

The modernization of regulatory systems by Saudi Arabia and the establishment of the Dubai

International Financial Centre (DIFC) are indeed steps in that direction. Further market

liberalizations have been undertaken; some Arab countries have already started to take steps in

favor of opening their markets to foreigners in areas such as investment and stock-market

 

10 

 

participation where national privileges have been extended to other GCC nationals or to foreign

residents and, in some countries, to international investors (Hertog, 2007).

In addition, dealing in sophisticated products has also risen, and the asset allocation of

Gulf investors is considered much more sophisticated than during the 1970s boom (Hertog,

2007). According to the International Monetary Fund (IMF), Dubai has emerged as the world’s

largest project finance market, with developments estimated around $700bn. The rapid growth of

Islamic finance and Sharia-compliant products is another aspect of the trend towards

sophistication. With a yearly growth rate of 45%, Sukuk has become an increasingly popular

source of financing for companies and a very attractive asset for local and foreign investors. In

the first half of 2007, the UAE accounted for 52.7% of the total global capital raised through

Sukuk, and now the country’s companies hold $22bn worth of Sukuk (Kuwait Finance House,

2007; Global Investment House, 2008).

These factors have triggered the influx of further Gulf funds into the Arab financial

markets, accounting, for instance, for more than 20% of the traded volume on the Jordanian

stock market (Hakim, 2008). Even international investors are being attracted to markets where

investment restrictions have been alleviated. This has translated into an international confidence

in Arab economies and has been reflected in rising international capital flows. The Middle East’s

share of global Foreign Direct Investment (FDI) has grown from 0.4% in 2000 to 4.1% in 2005

(Hertog, 2007). In the Foreign Direct Investment Index (FDICI), the UAE has risen from the 22nd

position in 2005 to the eighth in 2007, and 29% of investors placed it in fourth place behind

India, China and Brazil in terms of increased investment optimism globally.

However, foreign investors insist more and more on transparent corporate governance that

reflects international standards encompassing the combination of laws, regulations and listing

rules that enable the corporation to meet legal obligations and general societal expectations as

well as serve the interests of its shareholders (Mardjono, 2005). Research findings suggest, for

instance, that the poor governance practices of companies deterred half of US and European

investors from investing in them. The acknowledgment of the need to meet the higher

expectations of foreign investors in terms of both corporate and public governance and to

 

11 

 

persuade them that they can confidently invest in their countries or companies led to the

initiation of additional reforms.

The regulators of several of the region’s financial markets have already initiated actions

that reflect their recognition that sound corporate governance practices should be not only in the

hands of the corporations, but also supported and guided by market authorities. The Emirates

Securities and Commodities Authority (ESCA), a regulatory body that supervises all aspects of

financial market activities, issued in 2007 a code of Corporate Governance with which all

companies listed on the Abu Dhabi Stock Market are required to comply. The standards are

aligned with the international Best Practices of corporate governance related to the role of the

Board of Directors and its committees, audit and control mechanisms, transparency, and the

rights of shareholders. The Bahrain Stock Exchange (BSE) focused on introducing disclosure

requirements relating to share prices, performance of listed companies and investors’ activity in

an attempt to attract and encourage the participation of a large number of small and international

investors. Other regulations included measures to control insider trading and ownership activities

subject to holding percentage limits (Rao and Shankaraiah, 2003) and were later amended in

2007 by the Central Bank of Bahrain. Also aimed at stimulating investment in the market, the

easing of mutual funds regulations and tightening of insider trading laws have been undertaken

by the Oman market authority.

In Saudi Arabia, the Capital Market Authority (CMA) was established in 2003 to develop

and regulate the country’s capital markets. In 2007, the CMA not only started drafting corporate

governance guidelines but also acted as a “watchdog” in the marketplace by imposing regulatory

actions, initiating investigations and taking disciplinary procedures against more than 80

companies for cheating. Other poorly performing Saudi agricultural companies were also

delisted, as noted by a 2008 report by the Kuwait Financial Center. The regulators also released

guidelines governing mergers and acquisitions for listed companies. The listing rules on the

Saudi market require a three-year track record of operation, past profitability, sound balance

sheets and minimum paid-up capital of SR75 million.

Since the principles of corporate governance encompass transparency, improving

accountability and responsibility, allocating responsibilities and clearly defined roles, reducing

 

12 

 

corruption, decentralizing decision making, recognizing ownership needs, and managing

resources better (Mardjono, 2005; Rhodes, 1996), these principles are believed to lay the ground

for improvements at the public governance and democracy level. The critical driving factor here

is building awareness of practices of governance that promote fair treatment among the

participating public. This is in line with the view that, in order to introduce a change in the

thinking and behavior of citizens, reform initiatives must begin from the “inside or from the

grass-roots level” (Laurila and Singh, 2000).

In practice, once the customs of sound governance emerge at the corporate level, they are

progressively disseminated among communities and the employees of governmental institutions.

Citizens will gradually move from a position where they are accustomed to accepting the status

quo to a position where they acknowledge their rights to be fairly and equally treated, to receive

transparent and accurate information, to express concerns to authorities in relation to their

practices in serving the public interest, and to impose penalties for violation of laws and abusive

behaviors. They will eventually learn to stand up for those rights. As they become accustomed,

as controlling or minority shareholders in corporations, to having the right to elect board

members who represent and protect their interests, citizens will acknowledge that politicians also

need to be elected to represent the will of the people. These ideas are aligned with the view

expressed by Gompers, Ishii and Metrick (2003) that “corporations are republics”.

The same reasoning applies to the rights to express opinions and concerns and to impose

corrective actions. From an awareness of governance at the corporate level arises the

community’s awareness of its right to public debate and deliberation. Citizens, NGOs,

journalists, and other social actors will be encouraged to use different forms of public expression

and to bring to public attention political or social issues such as corruption. This will constitute

the preliminary phase of political and social change, as it triggers a debate on the search for

optimal solutions and encourages reform. For instance, as corporate governance allows

shareholders to monitor the performance of directors and managers and grants them the right to

take corrective and disciplinary actions in case of inefficiency or misconduct, citizens will

gradually expand this awareness of their rights to the broader environment, namely the political

system. They will learn to vote corrupt politicians out, thus giving the latter incentives to work in

 

13 

 

the public’s best interests. According to the World Bank (1997), the latter practice has been

observed in democratic countries.

Furthermore, when transparency and accountability practices spread to public dealings and

governmental activities, citizens will be able to increase participation and delegate power and

control to local organizations (Brinkerhoff, 2000). Additionally, decentralized mechanisms are

more effective and democratic and help in dispersing control horizontally, thus distributing

influence more widely and creating equal exercise of political freedom and effective social

freedom (Bohman, 1999). As Richards (2005) points out, such an environment will prevent

corrupt elites from wasting public resources and enriching themselves at the expense of human

capital formation. This environment could also lead to the end of economic power being

concentrated in political figures and to more equitable distribution of income. This would be a

step towards Marquette’s (2001) proposal that, in a democracy, social, political and economic

priorities should be agreed upon, and citizens should express their opinions on the allocation of

resources and on matters affecting their well-being. Thus, corporate governance is regarded as a

weapon for fighting corruption in a country and promoting democratic acts and practices

(Santiso, 2001), and raising awareness is a significant democratic exercise in itself. Indeed, the

effect of sound governance has already started to spread to the public level in the GCC countries.

The control of corruption indicator published by the World Bank has improved, on average, from

0.11 to 0.69 in the ten-year period 1996-2006 (Kaufmann, Kraay and Mastruzzi, 2007).

Thus, the move towards more liberal and open financial markets and economies and more

equitable distribution of wealth, as well as the loosening of governmental control on the

economy, will no doubt facilitate the adoption of more democratic mechanisms. In summary, the

argument that the economic reform currently underway in the Arab countries may be considered

a step towards political reform stems from a number of factors: (1) the emergence of a will

among the ruling elites to give away some power over interests (economic ones at least); (2)

encouragement of increased participation by the public and more equitable distribution of

wealth; and (3) gradual building of awareness among the public of sound governance and

consequently democratic practices, the creation of a strong civil culture and a middle class that is

aware of its rights and the ways to claim them.

 

14 

 

Although Ehteshami and Wright (2007) view these changes as an attempt to liberalize

rather than implement substantive reforms in political regimes, they argue that even

liberalization can be seen as a stage in the enfranchisement process, where power is transferred

to civil society and reforms are driven from below. In fact, the European Bank for

Reconstruction and Development Transition Report (1999) finds a positive correlation between

economic reform and democratization after ten years of transition, and it suggests that the

relationship between these factors is bidirectional. It appears from several examples, such as

Rwanda, Russia, Chile, and China, that democracy can be instituted at almost any stage in the

developmental process, regardless of factors such as social structure, economic conditions,

political traditions or external relations, and that democracy eventually stimulates development

(Leftwich, 1996).

NEED FOR POLITICAL REFORMS TO SUSTAIN ECONOMIC GROWTH

In the same vein, Laurila and Singh (2000) consider that democratic institutions prosper

following economic growth that is achieved by a well-governed corporate sector. Their

arguments support a gradual transition, rather than a fast one that occurs all at once. They argue

in support of the Washington Consent recommendations for starting the transition with

macroeconomic reforms and opening the economy to foreign competition (liberalization,

stabilization and fiscal austerity) and some microeconomic reforms (privatization, promoting

Foreign Direct Investments, property rights). However, the growth at the economic level could

not be sustained if the reforms were not carried out at the next level, the political one. Richards

(2003) contends that nations cannot rely solely on markets to allocate resources and raise their

wealth. Economic reforms would be insufficient to raising income and employment and

attracting foreign investments; it is unlikely that an arbitrary, authoritarian regime would be

successful in attracting private local and foreign investments, which give special consideration to

the degree of predictability and accountability in the marketplace. When a business operates in

an environment where corruption and lack of democracy reign, this business is very likely to get

caught up in the corrupt practices prevailing in its external environment, consequently harming

the achievements at the economic level, even if the culture of the business preaches good

corporate governance. Corruption in the private sector resulting from corruption in the public

 

15 

 

sector undermines the value of businesses as well as the value and image of the country itself,

hence hampering its growth and prosperity. In the same way, corruption and poor public

governance would lead to adverse consequences in public administration areas such as revenue

collection, revenue allocation, resource mobilization, and public regulation (Chipalkatti, Le and

Rishi, 2007).

Laurila and Singh (2000) thus contend that the focus has to shift to reforming public sector

governance in order to support the macroeconomic reforms undertaken and the strong

establishment of the corporate sector. The sequence they observe starts with macroeconomic

reforms, followed by reforms of public governance and the development of the corporate sector,

which serves to finance the improvement and maintenance of public governance and democratic

institutions. The last step is the establishment of democratic institutions. The authors state that

developing countries started by developing their commercial markets, followed by a democratic

restructuring.

The World Bank also considers that political reform remains a vital component at the heart

of any initiative towards democracy and away from corruption (Marquette, 2001). Thus, a

simultaneous strengthening of incentives for environmental protection needs to be undertaken

(Richards, 2003). In order to achieve long-term stability and sustain economic achievements,

greater governmental accountability and more transparent rules of the economic games are

certainly needed. In fact, a study by the World Bank (2003) on the MENA region reveals that

these countries would be able to achieve annual growth rates more than 1% higher if they had

administration in the public sector comparable to that of a group of well-performing Southeast

Asian countries. Thus, inasmuch as the government expects the private sector to adhere to the

highest standards of corporate governance, the government itself and its agencies must be

subjected to the same kind of scrutiny. A good governance system should exist at the public level

to manage public affairs in a transparent, accountable, participatory and equitable manner

(Santiso, 2001). There is, hence, a close relationship between appropriate corporate governance

and the political, institutional and social conditions in the country concerned.

Views concerning the need for democratic practices to maintain reforms at the economic

and corporate levels are supported by several arguments and seem to be viable in light of the real

 

16 

 

experiences of some countries and the empirical evidence relating to the link between

democracy, governance and economic growth. Richards (2003) provides the opposing examples

of South Korea and Indonesia. With institutional reforms enhancing accountability and

predictability, South Korea was able to recover from the Asian financial crisis of 1997, while

Indonesia, which did not undertake such reforms, suffered heavily from it.

Although the prior evidence on the impact of democracy on economic growth is

inconsistent, by aggregating the previous results, Doucouliagos and Ulubasoglu (2008) find

evidence that democracy has not a direct impact on economic growth but an indirect one,

through greater human capital, lower inflation, less political instability and greater economic

freedom. Richards (2003, 2005) contends that improved accountability at the public level would

alleviate poverty, have a positive effect on economic governance and stimulate investment and

the sustainable growth of the “wealth of nations”. The findings of Rivera-Batiz (2002) support

this view. More democratic countries are found to have higher quality of governance. In turn,

governance in improving democracies seems to make an effort to fight corruption by granting

freedom of the vote and press, thus making information on corrupt officials available and raising

levels of accountability. Consequently, democracy is found to impact long-term economic

growth positively by influencing governance. Introducing democratic processes would also

provide support for long-term economic reform by placing constraints on the powers of elite

groups, safeguarding property rights and adopting transparent procedures (The European Bank

for Reconstruction and Development Transition Report, 1999). According to Brinkerhoff (2000),

democratic governance creates motivation, allows the private sector and societal groups to

participate in forming policies and increases the management quality of such policies, all of

which help in increasing the efficiency and effectiveness of sectoral reforms. Additionally,

several researchers note that instituting democracy would limit state intervention in the economy;

respond to the public’s demands in areas such as education, justice and health; and encourage

stable and long-term growth (Baum and Lake, 2003; Rodrik, 1998).

Public governance and the existence of democratic institutions identified by the absence of

corruption and other risk factors are also positively associated with the ability of Emerging

Capital Markets (ECM) to attract foreign equity flows, since such sovereign characteristics

 

17 

 

would provide assurance for investors as to the safety of their funds (Chipalkatti, Le and Rishi,

2007). From a similar perspective, Marquette (2001) reports that bilateral donors think that

democracy reduces opportunities for corruption and thus focus on strengthening democracy as a

priority. The World Bank also considers corruption manifest in countries that are institutionally

weak and have low levels of accountability, rule of law and participation, yet it does not insist on

democratization as a prerequisite for support. Donors’ focus on democracy might be driven by

concerns that in non-democratic environments, populations would be deprived of the right to

express their opinions and would have no access to transparent institutions and a free press.

Consequently, they would have no control over corrupt behaviors by government officials or

authorities that would lead to default on sovereign debt. Such defaults would make the levels of

poverty in these countries hit uncontrollable highs (Goetzmann, 1999).

In light of these arguments and findings linking sustained economic growth to democracy,

it seems plausible to consider that the Arab countries aiming to expand their economies further

are presented with strong incentives to proceed with their reform plans and take them to the

political level. The Saudi government, for instance, would be motivated to institute further

reforms in order to promote sustainable growth in the IPO market, which is exploited in

financing its infrastructure projects and in implementing its privatization program (Hakim,

2008). Despite the improvements made, regional and international investors face considerable

obstacles in investing their capital, such as bureaucratic opacity, complex and outdated

regulations and non-transparent licensing policies (Hertog, 2007). Further, a large proportion of

the population is still young (33% in Saudi Arabia and 43% in Oman are under the age of 14);

the threat of facing future unemployment problems is turning into a political issue, facing the

countries of the region with the need to sustain economic growth and create work opportunities

for the future working population. The expected population growth is also expected to increase

the strain on public services such as education facilities (Ehteshami and Wright, 2007).

Consequently, further reforms would contribute to resolving these issues and would also allow

the countries in the region to achieve their ambitious visions of expanding their economies,

attracting capital and creating investment opportunities for locals and foreigners.

 

18 

 

It follows that the relationship between economic reform, governance and democracy is

double-sided: as much as economic reform is adopted as a means to achieving democratization,

reaching economic goals and sustaining them in the long run requires countries of the region to

institute democratic procedures.

CONCLUSION

Richards (2005) asserts that the questions of “Who will effect a transition to more

democratic governance?” and “How will this transition happen?” cannot be answered in

advance; he also claims the transition from an authoritarian to a democratic regime cannot be a

simple one anywhere in the world. This paper does not attempt to present the drivers for

democratic reform in the Arab region; rather, it argues that the trend towards the establishment of

open and well-governed financial and economic markets that is currently observed in the region

is a step towards democratic reform.

The Arab countries appear to be following in the footsteps of China in instating economic

reform as a step towards political reform. China has had a successful experience in making huge

market reforms, improving living standards, introducing liberalization and implementing a

gradual process of overall reform that has allowed the country to achieve the transition to a

modern market economy that has expanded nine-fold in 25 years. Zhang (2006) argues that this

has permitted China to institute political reforms. While these political reforms are not

necessarily associated with abandoning the political system and do not necessarily mean

democratization as the West understands it, the reforms aim for political rationalization and

improving the efficiency of the existing political system in order to facilitate rapid economic

development. Thus, according to the author, China has achieved major democratic

transformations relative to the country’s scale, and the economic reforms have set the pattern for

future political reforms.

In the case of the Arab countries, the initiatives undertaken at the economic level reflect a

certain level of willingness among the ruling authorities to move in the direction of political

reform as they promote heightened participation in the private sector and more equitable

distribution of wealth. These initiatives also have a positive effect on building awareness of

 

19 

 

sound democratic governance among citizens and authorities. By being exposed to sound

governance practices at the corporate level, citizens can begin to acknowledge and claim their

rights to express their opinions and to have access to transparent information not only in the

corporations they invest in, but also in their governments.

While the task of liberalizing the markets and the economy and bringing them up to

international standards is now underway, the positive consequences of such initiatives could not

be sustained in the long run unless steps towards more democracy and less corruption are taken.

Thus, the initiated economic reforms are considered not only steps towards democracy but also

forces that create incentives that pave the way for further democratic and political reforms. The

potential heightened awareness of and spread of demands for good public governance by

communities; the pressures to sustain long-term economic growth, reduce poverty, and create a

middle class; the openness to competitive markets; and the attraction of foreign investors are

factors that the countries of the region are eager to develop and sustain. Such factors in turn drive

the need to support them with a gradual reform of political systems. Central to achieving this

objective is gaining a reputation for equity, fairness, transparency, accountability, and

responsibility and crafting effective governance practices. Thus, much as a corporation faces the

need to institute corporate governance to serve its shareholders efficiently, maximize their wealth

and treat them equally, a nation faces the need to adopt democratic practices that ensure that their

citizens’ will is being served, their resources efficiently employed, their economic wealth

maximized and fairly distributed and their participation encouraged. As Santiso (2001) asserts,

the challenge of countries would then be to bridge the economic and political gap by integrating

them into a single strategy.

Despite the promising nature of recent developments and reforms, whether they will lead

to notable improvements in democratic practices and whether the issues and obstacles that

characterize countries in the region can be overcome are questions that remain open to debate.

While authorities in the Arab countries seem to have started to give away some of their control

over economic interests, it is not clear whether they would tolerate giving up some of their

political power. All depends on the true will of political leaders and the awareness among

communities and authorities of the rights of citizens.

 

20 

 

 

21 

 

REFERENCES

Mariam Al Hakeem, “Saudi Arabia Makes Progress by Slashing Poverty in Record Time,” The Region, April 26, 2007.

Baum Matthew and David Lake, “The Political Economy of Growth: Democracy and Human Capital,” American Journal of Political Science, Vol. 47, No. 2 (2003), p. 333.

Jagdish N. Bhagwati, “Directly Unproductive, Profit-Seeking DUP Activities,” Journal of Political Economy, Vol. 90, No. 5 (1982), p. 988.

James Bohman, “International Regimes and Democratic Governance: Political Equality and Influence in Global Institutions,” International Affairs, Vol. 75, No. 3 (1999), p. 499.

Derick W. Brinkerhoff, “Democratic Governance and Sectoral Policy Reform: Tracing Linkages and Exploring Synergies,” World Development, Vol. 28, No. 4 (2000), p. 601.

Louis Cantori, “Political Succession in the Middle East,” Middle East Policy, Vol. 9, No.3 (2002), p. 105.

Niranjan Chipalkatti, Quan Le and Meenakshi Rishi, “Portfolio Flows to Emerging Capital Markets: Do Corporate Transparency and Public Governance Matter?” Business and Society Review, Vol. 112, No. 2 (2007), p. 227.

Credit Suisse, “Saudi Arabia: Strong Inflationary Pressures are Likely to Persist near Term,” December 19, 2007.

Heather Deegan, “The Middle East and Problems of Democracy”, (Open University Press, 1993), p. 9.

Guilain P. Denoeux, “Corruption in Morocco: Old Forces, New Dynamics and a Way Forward,” Middle East Policy, Vol. 14, No. 4 (2007), p. 134.

Hristos Doucouliagos, and Mehmet Ali Ulubasoglu, “Democracy and Economic Growth: A Meta-Analysis,” American Journal of Political Science, Vol. 52, No. 1 (2008), p. 61.

Anoushiravan Ehteshami and Steven Wright, “Political Change in the Arab Oil Monarchies: From Liberalization to Enfranchisement,” International Affairs, Vol. 83, No. 5 (2007), p. 913.

European Bank for Reconstruction and Development, “Transition Report 1999. Ten Years of Transition. Economic Transitions in Central and Eastern Europe, the Baltic states and the CIS,” (London, 1999).

Paul A. Gompers, Joy Ishii and Andrew Metrick, “Corporate Governance and Equity Prices,” Quarterly Journal of Economics, Vol. 118, No. 1 (2003), p. 107.

 

22 

 

Sam R. Hakim, “Gulf Cooperation Council Stock Markets since September 11,” Middle East Policy, Vol. 15, No. 1 (2008), p. 70.

Steffen Hertog, “The GCC and Arab Economic Integration: A New Paradigm,” Middle East Policy, Vol. 14, No. 1 (2007), p. 52.

Benjamin Isakhan, “Engaging “Primitive Democracy”: Mideast Roots of Collective Governance,” Middle East Policy, Vol. 14, No. 3 (2007), p. 97.

KAMCO Research, GCC Equity Markets Monthly Review, December 2007.

Global Investment House, “Sukuks – A new dawn of Islamic finance era...” January, 2008.

William Goetzmann, “Democracy before Debt,” The New York Times, October 22, 1999.

Mehran Kamrava, “Democracy in the Balance: Culture and Society in the Middle East,” (Seven Bridges Press, 1998).

Daniel Kaufmann, Aart Kraay and Massimo Mastruzzi, “Governance Matters VI: Aggregate and Individual Governance Indicators 1996–2006,” World Bank Policy Research Working Paper 4280 (2007).

Elie Kedourie, “Democracy and Arab Political Culture,” (Washington Institute for Near East Policy, 1994).

Anne O. Krueger, “The Political Economy of the Rent–Seeking Society,” American Economic Review, Vol. 64, No. 3 (1974), p. 291.

Kuwait Finance House, “Bond Pulse,” June 18, 2007.

Kuwait Financial Centre S.A.K “Markaz” “Outlook 2008: Saudi Arabia,” January, 2008.

Juhani Laurila and Rupinder Singh, “Sequential Reform Strategy: The Case of Azerbaijan,” Bank of Finland, Institute for Economies in Transition BOFIT, No. 8 (2000).

Adrian Leftwich, “Governance, Democracy and Development in the Third World,” Third World Quarterly, Vol. 14, No. 3 (1993), p. 605.

Adrian Leftwich, “On the Primacy of Politics in Development,” in A. Leftwich (ed.), Democracy and Development (Cambridge: Polity Press, 1996).

Loeffler Tuggey Pauerstein Rosenthal LLP, “Document: Terms of Saudi Arabia’s Accession to the WTO,” Middle East Policy, Vol. 13, No. 1, p. 24.

Amerta Mardjono, “A Table of Corporate Governance: Lessons Why Firms Fail,” Managerial Auditing Journal, Vol. 20, No. 3 (2005), p. 272.

 

23 

 

Heather Marquette, “Corruption, Democracy and the World Bank,” Crime, Law & Social Change, Vol. 36, No. 4 (2001), p. 395.

Pippa Norris, “Critical Citizens: Global Support for Democratic Government,” (Oxford University Press, 1999).

D.N. Rao and Kanukuntla Shankaraiah, "Stock Market Efficiency and Strategies for Developing GCC Financial Markets: A Case Study of Bahrain Stock Market," (2003), Available at SSRN: http://ssrn.com/abstract=410200,

Rod Rhodes, “The New Governance: Governing without Government,” Political Studies, Vol. 44, No. 4 (1996), p. 652.

Alan Richards, “Democracy in the Arab Region: Getting There From Here,” Middle East Policy, Vol. 12, No. 2 (2005), p. 28.

Alan Richards, “Modernity and Economic Development: The New American Messianism,” Middle East Policy, Vol. 10, No. 3 (2003), p. 56.

Francisco L. Rivera-Batiz, “Democracy, Governance and Economic Growth: Theory and Evidence,” Review of Development Economics, Vol. 6, No. 2 (2002), p. 225.

Dani Rodrik, “Why do More Open Economies Have Bigger Governments?” Journal of Political Economy, Vol. 106, No. 5 (1998), p. 997.

Shuaa Capital, “Vision 2008, Saudi Arabia Equity Markets”, January 16, 2008.

Carlos Santiso, “International Co-Operation for Democracy and Good Governance: Moving Toward a Second Generation?” European Journal of Development Research, Vol. 13, No. 1 (2001), p.154.

http://www.undp-kuwait.org/undpkuw/poverty.html

http://www.undp.org.bh/povertyreduction.html

Shang-Jin Wei, S.J., “Natural Openness and Good Government”, National Bureau of Economic Research, Working Paper 7765, June, 2000.

World Bank, “Doing Business 2008,” September, 2007.

World Bank, “The State in a Changing World: World Development Report 1997,” (Oxford University Press, 1997).

World Bank, “Better Governance for Development in the Middle East and North Africa: Enhancing Inclusiveness and Accountability,” (World Bank, 2003).

 

24 

 

Wei Wei Zhang, “Long-Term Outlook for China’s Political Reform,” Asia Europe Journal, Vol. 4, No. 2 (2006), p. 151.