In the second of a series of articles on the Middle East, Dubai International Financial Centre Authority chief economist Dr Nasser Saidi says that a new world order is required with the West no longer being the centre of the economic world

The countries of the Middle East accustomed to living in a volatile regional environment are facing the additional challenge of adapting to the emergence of a new world order resulting from a new global economic geography.

The forces at work are momentous and will not be denied: they require structural adjustments in policies and orientations of the economies, societies and politics of the wider Middle East.

Starting with the Asian crisis and heralded by the dot.com crisis, it is clear that a fundamental, structural shift in the geography of the global economy is underway – a shift that is reinforced by the current “Great Recession”.

In 30 years, the geographic epicentre of the global economy has shifted from the mid-Atlantic between London and New York to a point somewhere between Dubai and Shanghai.

Today Asia and the Middle East account for more than 40 per cent of the value of world output at purchasing power parity rates (PPP), while the US and Europe each account for 20 per cent.

By 2013, the International Monetary Fund estimates that the total GDP of emerging and developing economies, at PPP rates, would overtake that of advanced countries for the first time since the late nineteenth century.

Emerging economies will account for 50.6 per cent of global GDP versus 49.4 per cent for advanced countries.

In fact, since 2000, emerging market economies (EMEs) have been the drivers of global economic growth, accounting for two thirds of global economic growth over the past eight years and more than 80 per cent of the budding recovery in global economic growth in 2009.

EMEs are also altering and dominating world trade patterns and trends. The growth of world trade is largely due to the EMEs and increasingly it is intra-EME trade. In particular, China’s trade pattern is shifting towards Asia and the Middle East, leading to increased regional economic integration.

Current account balances of EMEs, which were chronically in deficit during the 1990s, have swung into surplus, and are projected to remain that way, while developed economies look set to fall into even deeper current account deficits through, at least, 2011. By the end of 2010, EMEs would have accumulated in excess of €3.2tn ($4tn) in international reserves, implying growing power in international financial markets.

Increasingly, international capital flows are being dominated by EMEs, who are now the dominant investors in other EMEs: foreign direct investment (FDI) is progressively more South-South, breaking the historic pattern of North-South FDI flows.

The shift in economic geography is increasingly reflected in an accelerated shift in global financial geography. In 1999, US capital markets represented 46 per cent of the world total, according to Standard & Poor’s estimates of the total value of the world’s equity markets.

A decade later, by the end of 2009, they represent just 28 per cent. Meanwhile, in 1999, emerging capital markets made up just 8.3 per cent of the global total but by the end of 2009 grew to 32 per cent of global markets.
The BRIC countries represented 2 per cent of world equity markets in 1999 and are now 19 per cent; an eight fold increase in the space of one decade. Nascent Gulf Cooperation Council markets are now 1.2 per cent of world markets, growing from a mere 0.3 per cent in 1999.

For more than 100 years, a “hub and spoke” model has dominated and defined global capital markets. In this model, excess savings – initially from countries such as the UK and later the United States – would flow to international commercial and investment banks in London or New York. This capital would then be deployed in investments across the globe, into the “spokes”, the peripheral exchanges.

This may have been appropriate when most global output, savings and capital markets were located in the West, and later also in Japan. But that is an obsolete system for a world that no longer exists. The United States has gone from being an exporter of capital to a massive importer of capital, absorbing two-thirds of all savings worldwide to fund its twin current account and budget deficits. These deficits were covered in large part by key emerging market economies (mainly China and the GCC) which ran persistent large current account surpluses over the past decade – such as China and the Gulf states.

Such a state was clearly unsustainable – neither the imbalance between countries with high savings rates and those with low or even negative savings rates, nor the hub-and-spoke model is an efficient distributor of global excess savings. The hub-spoke model has failed, begetting international financial centres that were too big to fail and too interconnected to fail, with financial institutions that were inefficiently regulated and supervised and themselves TBTF and TITF. The main point is that the large accumulation of savings at the big international banks has consistently led to less-than-ideal lending practices, as both the Latin American and current crises have shown.
The hub-spoke model created systemic financial market risk. The fear of failure in the hubs provoked global risk aversion and led to contagion effects affecting the emerging markets and their economies.

We must not allow this to happen again. We need to design and move to a new international financial architecture of networked financial markets, to a more stable and sustainable spider web model based on the new economic geography. The emerging spider web markets all have names ending in ‘ai’: Dubai, Mumbai and Shanghai.

The emerging economies of the Middle East and GCC need to develop their own local currency capital and financial markets with the capital market depth, the technological market infrastructure and regulatory sophistication to absorb excess capital from their own regions, as well as from elsewhere.

That is the strategy underlying the Dubai International Financial Centre. The capital exporting countries of the Middle East have an entrenched interest in the design of the new economic and financial architecture and its governance.
This is the new financial architecture that is needed – not only by these regions and their economies, but also by the global capital system as a whole.

A spider web model would help prevent the enormous concentration of savings in just one or two financial centres, creating an unstable sloshing of large waves of capital.

Having weathered the tsunami, the GCC countries will be able to continue their own “Great Transformation” based on their oil wealth. In a recent DIFC study, we estimated that the present value of the GCC’s oil and gas exports revenues to 2030 is €30.1tn ($37.7tn) - assuming a price of oil at €80 ($100) per barrel - equal to the world’s total stock market capitalisation at the end of 2008.

This wealth makes the region in its own right a centre of finance that has a major role to play as part of the emerging, new international financial architecture. But this wealth also requires the continued development of wealth management capacity in the region and the further maturing of capital markets, to absorb and deploy this wealth, both regionally and internationally.

As the region’s financial wealth grows, income on assets will become more important than income from energy production. Increasingly income diversification for the oil-producers means increased diversification of production as well as diversification of income sources.

To reap the benefits of this process and acquire a more decisive role, the GCC countries which are already linked in a lively cooperation framework, should become deeply integrated. They need to foster greater regional integration and policy harmonisation in trade, direct and portfolio investment, labour mobility, infrastructure services, environmental issues, financial regulation, and statistical capacity.

Greater regionalism should be high on the policy agenda, with the GCC countries at the core of the Middle East, North Africa and South Asia, also known as the Menasa region. Economic integration should be accompanied by monetary integration. A GCC Monetary Union is necessary to achieve monetary policy independence and the creation of a common currency, the “Khaleeji” pegged to a currency basket would create a new monetary asset that can evolve into an international reserve asset, backed by the natural resource and financial wealth of the GCC.

It would also be desirable to devise new institutional structures as vehicles to remove the barriers and constraints on growth. It is time to launch a Menasa Development and Reconstruction Bank able to finance economic development and intervene in reconstruction hotspots such as Iraq, Pakistan, Palestine, Lebanon, and Sudan and undertake a program to bolster regional infrastructure.

The year 2008 will be a defining moment in post World War II history, marking a watershed for financial markets, marking the end of the American financial empire.

We are challenged to re-design the existing financial architecture which has been in place for nearly a century and the Bretton Woods system. This is a time for bold vision and action.

A new economic geography with a renewed dominance of emerging markets requires a new global financial geography. We are moving away from a unipolar to a polycentric world order.

The West will no longer be the standard or the arbiter of what it means to be modern. Political, social and ethical values, economic and financial orthodoxy, policy recipes, and as a consequence, the moral high ground, will have to be redefined in a new reality. For the foreseeable future we will be dancing to a Chinese tune.

Dr Nasser Saidi is chief economist of Dubai International Financial Centre Authority and executive director of Hawkamah Institute of Corporate Governance.