The current social unrest spreading throughout the Middle East has its roots in many causes. In some places, despotic leadership is no longer being tolerated. In other instances, such as Bahrain, religious groups that constitute a majority of the population have been shut out of important roles in the economy. Yet in all of the countries involved, one clear theme has emerged: The citizens are tired of corrupt, sclerotic and nepotistic leaders, and simply want improved access and a shot at a better lifestyle.

What’s in the interests of these citizens is also in the interest of investors. Corruption-free, merit-based economies are always the best place to do business. That’s why the Heritage Foundation annually issues a Freedom Index of 10 components that measure a series of “economic freedoms” such as business freedom, trade freedom, fiscal freedom, property rights and corruption.

It’s no coincidence that Iran, Syria, Algeria, Yemen, Tunisia and Morocco all occupy the bottom half of the Freedom Index rankings. Unless you are a member of the elite in these countries and have the ability to bribe and cajole your way into key business relationships, you may as well emigrate to more open economies. That’s why these economies have seen a steady brain drain for decades. If you are talented but lack opportunity in a place like Tunisia, then a move to France or Germany makes clear sense. Yet the current movements sweeping the region promise to reverse that brain drain and tear down the barriers to real economic improvement.

A messy interregnum
But investors would be mistaken to assume that a rapid transition to democracy will yield a sudden economic upturn. Instead, the opposite is likely to be true. Many of these economies are so structurally flawed that it will take quite a while before the conditions are in place for a sustained economic upturn. [I’ll tell you how I think investors could play these events in a minute…]

Iraq is a great example. That country has lost a dictator and opened up opportunities for the formerly dis-enfranchised Shiite majority. Yet the Iraqi economy is struggling with many growing pains, as government planners come to realize that bureaucracy is stifling any individual initiative. Iraqis have relatively high levels of education and, down the road, its economy is likely to be much closer to its full potential than it could ever be under Saddam Hussein’s control. But the country is crawling before it can walk, let alone being able to run.

One of the sobering realities of the current crisis is that many of these countries have real demographic problems. A massive baby boom has led to an explosion of people in their teens and twenties. This is the group that feels most helpless, due in large part to a lack of solid job prospects. In the near-term, new leadership will be unable to quickly bring down high youth unemployment rates, which may spell yet more social unrest in the next few years.

Ironically, Egypt’s economy had been on a nice growth spurt in recent years thanks to economic liberalization measures. Even after adjusting for inflation, GDP has expanded by around 6% in each of the past five years. Trouble is, growth has only benefited the upper echelons of society. Now, a number of parties that are running in the next elections seek to roll back many recent reforms, which could undo recent gains. In a sign of how fast things are moving, Naguib Sawiris, Egypt’s wealthiest man and leader of telecom giant Orascom Telecom Holding (ORSTF.PK), used to be a supporter of the resistance but now finds himself on the defensive. “Being rich is a crime now,” he recently told the Wall Street Journal.

Add it all up and you’ll have dubious economic and investment environment during the next few years. And don’t expect oil to save the day. High oil prices can help prop up government revenue, but they also tend to strengthen a country’s currency, known as “The Natural Resources Curse.” A strong currency makes a country’s exports less competitive, which ends up stimulating imports that take market share from locally-sourced (and more expensive) goods.

That’s why I think you need to avoid the exchange-traded funds (ETFs) of these countries and perhaps even look to short them. Sure, the Market Vectors Egypt Index (Nasdaq: EGPT) has already fallen 30% since the start of the year, but the ETF could fall yet further as the effect of the crisis is more deeply felt on the economy.

Much of the ETF’s holdings are comprised of large Egyptian companies that were the very beneficiary of a corrupt system. These companies, such as Orascom Telecom Holding, are controlled by Egypt’s elite families. Though these individuals are not corrupt in the context of their own economic environments (when in Rome…), many of their contracts may come up for bid in a more open process and threaten business.  The rules of the game are changing in favor of the non-elites.

Sawiris’ Orascom is the ETF’s largest holding and as a sign of how powerful that company is, four Orascom divisions comprise more than 40% of the fund.  The Egypt fund also owns a large chunk of Citadel Capital, which is run by the son of Hosni Mubarak, Egypt’s former military commander who resigned as the country’s president on Feb. 11 after 30 years in power. How long before Citadel’s assets and business practices come under greater government scrutiny?

I’m equally wary of the T. Rowe Price Africa & Middle East Fund (Nasdaq: TRAMX). Major changes in places like Jordan and Kuwait would roil this funds as well.

Action to Take –> The long-term implications of all this turmoil are quite positive. After experiencing real growing pains, countries such as Iraq and Egypt are set to become major two-way trade partners with the rest of the region. But perhaps the best way to play the region’s eventual renaissance is through Turkey.

As I wrote last year, “Turkey is possibly the most advantageously-situated country in the world, just steps away from Southern Europe, central Asia, Russia and the Middle East. As a result, the country is boosting trade in virtually every direction.” Indeed the iShares MSCI Turkey Invest Market Index (NYSE: TUR) has pulled back more than 20% in the past six months, creating a better entry point for this “safer” way to play the Middle East.

P.S. — Few investors realize that a 20-year energy agreement between the United States and Russia is about to expire. This deal supplies 10% of America’s electricity. As broke as our government is, the situation is so serious that President Obama is asking for $36 billion to avert this crisis. And Republicans support him. Here’s what’s going on…