Did Lack of Business Institutions Hold Back Middle Eastern Economies?

What will happen in the Middle East?  An often debated questions as millions struggle for their lives and the political and economic future of countries in that region remains a mystery.  An interesting take on the situation in the Middle East was a book The Economist reviewed last year by Timur Kuran, a Turkish-American economist from Duke University, which detailed his views on “how Islamic law held back the Middle East”.  The story goes back many centuries and it is fascinating to be reminded, or told for the first time, that scholars such as Angus Maddison have calculated that in the year 1000 the Middle East, buoyed by extensive trading communities in places such as Baghdad and Istanbul, accounted for 10% of the world’s gross domestic product (“GDP”) at that time while Europe trailed just behind with 9%.  However, by 1700 Europe’s share of global GDP stood at 22% while the Middle East had fallen off sharply to just 2%.

The Economist review summarized three standard explanations for the reversal of economic fortunes suffered by the Middle East during the Middle Ages and Early Renaissance including the widespread perception that Islam is fundamentally hostile toward commerce, the Islamic ban on usury and the belief that Muslims fell victim to European imperialism during that period.  However, the reviewer finds these explanations to be unsatisfactory noting, for example, that Islamic writings are more pro-businesses that Christian scriptures, the Koran is full of practice for commercial activities, Muhammad was a merchant and the ban on usury appears not only in the Koran but also in the Bible and the Torah.  For the reviewer, Kuran offers what is characterized as a “more plausible reason” for the Middle East falling behind Europe: the failure of the Middle East “to produce commercial institutions—most notably joint-stock companies—that were capable of mobilising large quantities of productive resources and enduring over time.”

The Economist reviewer summarized and contrasted the experiences of the Middle East and Europe with regard to recognition and use of business institutions and related issues such as privatization and entrepreneurship.  Europe was an early adaptor of sophisticated business institutions such as corporations—a concept borrowed from Roman law—and limited partnerships that could survive the departure of one of the partners and offered limited liability for passive investors.  This allowed major European trading houses to set up organizations with a large number of staffers spread across multiple countries.  In contrast, the Middle East relied primarily on simple partnerships that could be dissolved at any time by one of the partners and which were not suited for long-term wealth accumulation and centralized management of capital for the benefit of multiple claimants.  Europe’s advantage widened as its merchant firms developed and refined most sophisticated tools of capitalism such as double-entry bookkeeping and stock exchanges.

It is certainly true that over the last 100 years or so parts of the Middle East have moved aggressively to close the economic gap by adopting Western style institutions including secular legal systems, stock markets and large multinational corporations and a number of Middle Eastern countries have liberalized their foreign investment policies to attract capital, resources, technologies and management ideas from the West.  However, the effects of what Kuran calls the “long divergence” are likely to remain with the Middle East for a long time to come—income per capita is less than 30% of the European and US average; more than half of the businesses in the region suffer from lack of adequate access to electricity, telecoms and transport, all key resources for firms seeking to become and remain competitive; government influence on the economy remains high making it difficult for strong privately-owned companies to emerge; entrepreneurship is low in the Middle East and North Africa; and corruption remains high.

The reviewer closes by noting that while the Protestant work ethic and the Scientific Revolution were important for European economic progress they may have mattered less than previously thought and those involved in promoting economic development might be well advised to heed the lessons in Kuran’s story and focus on creating an institutional environment that supports and facilitates the creation and maturation of corporations and other institutions that allow labor, capital, technology and other assets to be combined and deployed in imaginative ways.

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