A major policy issue facing many of the countries in the Middle East and North Africa (MENA) is following the rest of the world in liberalizing, privatizing and deregulating markets. Reform efforts undertaken in the last decade in many countries of the region have been piecemeal, gradual, and not very successful. In Discussion paper No 1300 Research Fellow Bernard Hoekman and Simeon Djankov discuss the potential role of a Euro-Mediterranean Agreement (EMA) in helping Middle East and North African governments implement structural economic reforms. The economic arguments against preferential liberalization are well known. By discriminating in favour of specific countries, the possibility arises of trade diversion – the elimination of tariffs for partner countries may induce consumers and firms to source from less efficient suppliers located in a partner country, rather than from the least cost source of supply. This is potentially a serious problem in the EMA context, especially in so far as partner countries will lose the tariff revenue collected on imports of EU origin without obtaining offsetting improvements in access to the EU.

The recently negotiated EMA between Tunisia and the EU is evaluated, using these conditions as criteria. Some doubts are expressed whether an EMA, by itself, will be enough to help countries in the region `catch up'. Significant supporting and complementary actions are likely to be needed. Key issues in this connection are the regulatory regimes relating to inward foreign direct investment and the service sector; a reduction in tariffs applied to the rest of the world; and the imposition of hard budget constraints on state-owned enterprises. These aspects are not subject to disciplines under the EMA.