Summary: The countries of the Middle East and North Africa (MENA) have lost the geographic advantage they used to have because of their proximity to the European Union at a time when Eastern Europe was effectively closed to open exchange with the West. The Central and Eastern European countries are beginning to exploit their own proximity, together with relatively low wages and significant stocks of human capital, and are formidable competitors with MENA. To compete, the MENA countries must implement more far-reaching liberalization, privatization, and deregulation. It has been a basic tenet in MENA countries that economic reform must be gradual to avoid causing social disruption. This has often meant little effort publicizing reform and mobilizing political support. Partial and slow reform has led to uncertainty in firms and households and a lack of credibility. The slower the pace of reform and the less comprehensive its scope, the greater the gap between MENA's performance and the rest of the world is likely to become. Without a significant private sector supply response and inward foreign direct investment, political support for reform will be limited, and a vicious circle may result. The creation of the World Trade Organization (WTO) and the offer of the European Union to establish a Euro-Mediterranean Economic Area provide possible institutional frameworks to make a gradual reform strategy more credible. Full participation in the WTO could move the trade regime closer to "good practices," improve trade institutions, help lock in trade reform, make trade policy implementation more transparent, diminish bureaucratic red tape, and force firms to go through GATT-sanctioned mechanisms for temporary safeguard protection. An agreement with the European Union to establish a free trade and investment area could offset some of the WTO's regulatory and administrative loopholes, could (by providing financial transfers) overcome resistance to reform, and could ensure investors that MENA governments are committed to far-reaching integration with the European Union. But neither option is a panacea. Both should be pursued simultaneously.
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