Mortgage Markets Will Strengthen Arab Middle Classes

Political theorists don't agree on much, but they tend toward a healthy majority on one issue: large, vibrant middle classes spur demands for greater democracy and help sustain democratic institutions.

In recent history, countries that have successfully transitioned to democratic pluralism tend to be those with strong middle classes. South Korea, Taiwan, Japan, Mexico and Chile all moved toward greater democracy after developing their economies and building middle classes. The Eastern European states that have shown the healthiest democratic transition -- Poland, Hungary, the Czech Republic -- also have the strongest middle classes. Meanwhile, support for democracy in the poorer Latin American countries is cracking as rising economic discontent and joblessness shatters middle class hopes and prompts calls for a return of strongmen.

As Middle East analysts and thinkers grapple with issues of democratic reform across their region, and Washington and Brussels contemplate policy options to promote democracy, a vital truth is worth remembering: The best hope for Arab democracy is the existence of a vibrant, economically strong middle class.

Over the past 30 years, Arab middle classes have been slowly choking. Arab economies have dramatically under-performed, leaving a wake of middle-class carnage. The Arab world has witnessed a near-zero percent growth rate over the past three decades, even as the economies of developing countries grew at a rate of 2.5 percent.

While the region's largely redistributive, patronage-driven model of economic development provided a social safety net for the poor and middle class in the 1970's-80's, demographic pressures since the early 1990's have put unsustainable strains on public finances. With more than half of all Arabs under the age of 21 and two-thirds under the age of 30, a severe jobs crisis is looming. The Middle East region needs to create 100 million jobs by the year 2020 to meet rising labor demand. The normally understated World Bank describes the situation as "the most intense pressure on labor markets observed anywhere in the post-World-War-II period."

Given this bleak landscape, those in Middle East development policy circles have been grappling with solutions that might trigger an Arab economic revival. Too often, however, the debate revolves around the fraying, neo-liberal "Washington consensus" ideas of liberalization, privatization and free trade -- ideas that retain merit, but have yet to fulfill their promise in stunted economies with authoritarian leaders wary of the power of markets, and with political-business elites with vested, monopolistic interests in the status quo.

The development challenge in the Middle East is not a theoretical but a practical one. Policymakers and outside specialists must find pragmatic solutions to the region's economic woes that are widely acceptable to a range of stakeholders, including government, labor, the business community and international financial institutions. The region is littered with far-sighted theories that have met various walls of opposition, dying upon impact or barely scraping by, battered and stumbling into a slow death of shoddy implementation. The region needs bold ideas that can be implemented immediately.

In this quest for new ideas, two questions must be answered: First, what policy options might trigger domestic demand and sustainable growth in the non-oil states? Secondly, how might the rentier economies of the oil-rich states diversify their sources of income, spur domestic investment and demand, and thus create, genuine middle classes, not subsidy-addicted subjects?

The most valuable -- and workable -- idea floating around in development policy circles is the issue of mortgage finance. The idea is a simple one: create deep, long-term credit markets that will allow more people to own homes. With access to long-term mortgage loans, more Arabs can buy homes, offering them the dignity that comes with home ownership. But it goes beyond dignity. A vibrant mortgage market not only strengthens middle classes (as it did in America), but it also has enormous ripple effects on the economy, leading to increased demand for construction, cement, home consumer items and a whole array of home-related services.

A vibrant mortgage market will also lift up the region's banking systems and strengthen capital markets. As American scholars Walter Russell Mead and Sherle Schwenninger noted in their important work, Financial Architecture for Middle Class-Oriented Development, banking systems that rest on a diversified base of loans to individual home owners (such as the American system) are "inherently more stable" than systems characterized by a handful of loans to large borrowers (as in the Arab world). They write: "The U.S., for example, has what is widely considered to be the most flexible and best-developed capital market in the world. Yet mortgages remain the cornerstone of this market ... The existence of this large, stable pool of finance ... was absolutely critical to the development of U.S. capital markets."

In the Arab world, weak capital markets continue to plague economies and stifle potential. After all, the region does not lack capital: it is estimated that some $1.3 trillion of Arab private capital is invested abroad and untold billions swish around in offshore bank accounts. The region lacks sophisticated capital markets that can help channel this vast accumulated wealth into new projects. A thriving, well-regulated mortgage market, with its attendant effects on the economy and capital markets, will create new opportunities for investment and spur a return of significant Arab capital to domestic markets.

Perhaps most importantly, a far-sighted mortgage finance law is politically feasible since it will please just about everyone, from business elites who will benefit from new opportunities in construction and banking, ordinary Arabs who will find new homes affordable and new jobs arising from the business boost, and government officials who can point to tangible results from reform efforts.

The International Finance Corporation (IFC), the private-sector development arm of the World Bank, has been a trailblazer in the field of private mortgage finance in the region, developing and investing in projects in Algeria, Egypt, Palestine and elsewhere. But the IFC's resources are limited and its reach constrained by laws and governments that have yet to fully appreciate the enormous potential of mortgage finance. On this issue, the government -- not the private sector -- plays the critical role.

Here's where Arab governments can learn from America's example. During the American Depression of the 1930's, the U.S. Congress created Fannie Mae, the Federal National Mortgage Association, to make home mortgages more available. Fannie Mae proved to be an instrumental tool of America's recovery. Today, access to long-term credit for home mortgages forms the cornerstone of America's middle class and Fannie Mae, along with Freddie Mac, the Federal Home Loan Mortgage Corporation, continues to play a key role in helping Americans buy homes.

In the Middle East, a strong mortgage finance infrastructure won't magically produce democracy, but it will certainly boost regional economies, strengthen the middle class and build the foundation for a more hopeful future.