Historic political transitions in the Arab world are under way, but they are taking place against the backdrop of deteriorating economic conditions in the region—the unavoidable outcome of the Arab Spring’s destabilization and of the actions of investors and consumers who are confronted with enormous uncertainty. In Tunisia and Egypt, for example, two countries in which the transition to democracy is relatively more advanced, political uncertainty is undermining considerable pre-revolutionary economic achievements.

The good news is that the new Arab governments, and candidates for office, seem to recognize the seriousness of the economic challenges their countries face and appear prepared to address them constructively. This attitude, in turn, provides the international community with an opportunity to engage the Arab world and to help foster an economic environment that is supportive of the political transitions taking place.

Growing Economic Concerns

In 2011 in a number of oil-importing Arab countries, due in large part to radical changes in political structure that hindered forward-looking economic decisionmaking, economic activity slowed sharply—investment, consumption, and tourism were all affected—and unemployment rose. Across the Middle East and North Africa, real GDP grew half as fast in 2011 (2.2 percent) as in 2010 (4.3 percent). As a result, except in Morocco, per capita incomes stagnated or decreased in 2011, and more young people are without jobs today than a year ago.

Many Arab governments also have less room for policy maneuver due to worsening fiscal and external balances. Reflecting slowing growth and increased popular demands, the average fiscal deficit across the Middle East and North Africa mushroomed in 2011 to about 8 percent of GDP; government borrowing on such a scale, in turn, is crowding out lending to the private sector.

The economic impact of political uncertainty is being felt throughout the region but most strongly in countries like Tunisia and Egypt where democratic transitions are well under way. For the first time since 1986, Tunisia’s economy shrank in 2011, by 1.8 percent. Unemployment reached 18 percent last year, up from 13 percent in 2010. Meanwhile, the Egyptian economy contracted by 0.8 percent, and 1 million Egyptians have lost their jobs. Foreign investment flows have dried up in Egypt, falling from $6.4 billion in 2010 to a mere $500 million in 2011. Tourism has also collapsed.

These adverse trends are affecting the countries’ fiscal and external balances. Egypt’s budget deficit may widen to 10 percent of GDP this year, the highest for any Arab country, according to International Monetary Fund forecasts. Its reserves, meanwhile, have dwindled to $15 billion—barely enough to cover the country’s foreign exchange requirements for the next three months. In Tunisia, the budget deficit, which stood at 2.6 percent of the country’s national income in 2010, shot up to 6 percent in 2011 in the wake of the revolution.

Rapid economic deterioration across the region, in addition to high expectations raised by the onset of political transition, is creating a new sense of urgency among emerging political actors to develop more detailed economic programs and to address the economic grievances of their populations. Islamists’ discourse previously centered on political themes, highlighting issues related to political participation, inclusiveness, and democratic reforms. But in recent election campaigns, the rhetoric has shifted from politics to economics.

The economic programs of the emerging political players, and in particular the Islamist parties, are by and large market based, emphasize the role of the private sector in driving economic growth, and recognize the need to attract foreign capital. According to this approach, the state’s role is to serve as a vehicle for ensuring social justice, and there are few references to Islamic legal principles (sharia). For instance, in both Tunisia and Egypt, the political Islamists have given assurances that the vital tourism sector will not be subjected to restrictions based on Islamic law. The Islamists’ economic programs also anticipate a role for international institutions in efforts to address national economic challenges.

An Opportunity for International Partnership

Resistance to foreign intervention and assistance with respect to implementing democratic reforms remains strong, but the new Arab leaderships seem receptive to economic partnerships with the West and with multilateral institutions. The new governments are well aware of the benefits, including increased investment in their economies, improved market access, and the transfer of technical know-how. The real need in these countries for economic change provides an unprecedented opportunity for international engagement with the new Arab leaders.

Ideally, such a partnership would incorporate both short-term support and long-term development goals. But given that many of the Islamist parties have limited windows of time in which to bring about change before the people vote again, their immediate focus is likely to be on short-term goals that can be achieved within a single electoral cycle.

Creating jobs and managing expectations should be the core components of international partnerships with transitioning Arab nations. After all, the dearth of formal employment opportunities was at the heart of the popular dissatisfaction with incumbent regimes that eventually led to the Arab revolts, and the economic instability ushered in by this period of uncertainty has exacerbated problems in the labor market. Structural reforms, including education reform, training and skill building, and liberalization of the product, labor, and service markets, are indispensable for a sound job-creation strategy. But these reforms will only yield results in the long term, while Arab governments are under pressure to deliver jobs in the short term and to balance fiscal constraints with measures to stimulate job growth.

The Arab governments are also facing a serious challenge with respect to managing expectations. It is perhaps natural for the Arab citizenry to want and demand more from new, democratically elected governments in terms of job prospects, income, and standards of living. But governments run the risk of falling short of these high expectations. Policymakers and candidates in recent electoral campaigns have exacerbated this problem by announcing lofty economic goals. Their programs read more like a wish list than a serious agenda for what can be achieved within one electoral cycle.

If the new ruling parties fail to live up to their rhetoric in the coming years, there could be political repercussions ranging from diminished public support to popular disillusionment with the democratic experiment. The international community can help Arab governments take steps toward managing and tempering high public expectations.

Policy Support for the Political Transition

The only practical economic recipe for short-term job creation in the Middle East and North Africa consists of investments in large-scale public works. This type of government spending can create labor-intensive projects that will help address the problem of rising unemployment. The international community can help the Arab world launch and sustain such initiatives in four ways.

First, international actors can increase the amount of promised financial assistance. Egypt, for one, is negotiating a new loan of $3.2 billion with the International Monetary Fund. To be sure, that loan is probably inadequate given the Egyptian economy’s short-term financing requirements, even if the deal, as expected, opens the way to the release of funds pledged by Gulf countries. More funding is clearly needed to both support a more effective long-term job-creation strategy and boost the labor market in the short term.

Second, the international community can provide technical expertise to Arab policymakers on debt management. Without top-notch expertise in this area, large-scale public outlays could crowd out private investment by relying too heavily on domestic savings. This is already happening in Egypt, where the domestic banking system is being used to finance the country’s high budget deficit, undermining its ability to transfer these funds into productive private sector investments that can drive job growth.

Third, states and multilateral institutions can help Arab governments establish a secure and predictable legal and regulatory framework for public-private partnerships to undertake large-scale infrastructure projects. International actors, partnering with Arab governments, can then help to market these opportunities, enabling Arab economies to benefit from long-term international financing.

Finally, concluding deeper and more comprehensive trade agreements as contemplated under the G8 Deauville Partnership would help boost growth and efficiency mainly in the longer run. But they could also have a significant short-term impact on growth if the agreements entail meaningful liberalization and so boost the confidence of investors that countries will stay the course on market reforms.

Managing expectations is an arena in which domestic actors will have to take the lead, but the international community can help in a number of critical ways, including by facilitating more concerted engagement and dialogue on economic policy issues with the emerging political actors in the Arab world. This engagement can entail regularly inviting those actors to existing multilateral forums on economic policy or holding new multilateral forums focusing on the Arab world’s economic challenges.

Building the capacity to develop sound economic policy within these countries’ public administrations and civil societies—in part by establishing and improving independent economic policy think tanks—is also critical. Given the media’s instrumental role in shaping expectations, an ongoing training program for journalists and editors covering economic developments in the Arab world would be especially helpful. Such a training program would enable reporters to critically assess the new ruling parties’ economic agendas and frame the economic discussions taking place through a more realistic lens for the public.

Only a combination of these efforts will enable Arab economies to sustain growth levels capable of supporting a less volatile transition to democracy.

Sinan Ülgen is a visiting scholar at Carnegie Europe in Brussels.