Thursday, 3 February 2011

Oil, young people and private jobs: the major challenges facing the Gulf economies

The Gulf region is characterized economically by its large petroleum reserves which have financed the Gulf States’[1] economies since their discovery. Oil has brought huge wealth to the region, sustaining it by allowing high public sector employment rates and high government spending. Nevertheless, with a young and fast-growing population and the depletion of oil reserves inevitable, the public sector will be unable to absorb future job seekers and increase economic growth. The population of Saudi nationals alone will increase to 33 million in 2020 from just half that figure in 2000[2]. Many will be young entrants to the labour force as over 40% of the Gulf population is under 30 years old (see fig.1), and many sources put the figure higher[3]. The region faces unprecedented social and economic instability unless drastic reform measures are taken to ease the labour strain. The task of creating enough jobs to foster economic growth amidst substantial population growth and declining oil reserves has been identified as the most important challenge facing the GCC and the wider MENA region[4].



 Key:
  Under 15      
                                               
15 years and older    



Fig 1. Source: United Nations Development Programme, Arab Human Development Report 2005, published
 in Kito de Boer and John M. Turner, The Mckinsey Quarterly: Beyond Oil: Reappraising the Gulf States
Mckinsey &Company 2007, p11.

Previous oil revenue use has failed to create sustainable economic growth in the Gulf. The pertinent objective of the GCC states, as in all mineral rent dependant countries, is to compensate for the depletion of finite resources with sustainable productive assets by prudent investment of the existing resources. Previous political economic development strategies have proven to be inappropriate for the region, which suffers high levels of corruption, a lack of transparency, excessive military expenditure, an undersized private sector and continually high levels of unemployment.



Dubai has taken the lead in introducing outward-orientated growth strategies and with impressive results. However the region still requires massive structural adjustments including a move from oil dependence to non-oil dependence, from public, state-driven enterprises to private market-driven ones and from protected import-substitution to competitive export-orientated industries. Greater private sector trade and investment will be the key to achieving these policies. As this essay will demonstrate, political liberalization will be the key to the Gulf economies creating a viable non-oil dependant economic strategy able to secure sustainable economic growth, and this must be achieved by means of private sector expansion aided by the oil wealth.

Oil life and Population Growth
The estimated life of remaining oil reserves in the GCC differs between states (see fig.2) and those with shorter oil production capacity require more immediate diversification policies. Such is the case in Bahrain where necessary outward investment took place a number of years ago. The coincident political concessions in the kingdom indicate that economic and political reforms are somewhat complimentary.



Fig 2. Source: Calculated from EIA World Proven Crude Oil Reserves data for 2007 and EIA World Crude Oil Production data for 2006 at , published in Richards, Waterbury, 2008.






The demographic dynamic in the GCC is however more significant than oil depletion in that remaining oil production is estimated at more than 50 years for the major producers, (see fig. 2 above) whilst the populations of the GCC states will continue to increase significantly as oil output falls. Populations are expected to double in as little as 20 years for Kuwait, 25 for Saudi Arabia and Oman and 38 years for the UAE.[5] Declining oil reserves against a growing population signifies that the standard of living is unsustainable because the ratio of oil output per capita is falling. The following tables indicate this disparity.

                                                  Oil output value per day (millions US$ 2001)



                                                    GCC population (millions)




                           Oil output value per capita per day (output value per day/population) 
                           (US$ 2001)




Fig 3. Source: numerical data taken from ed. Heradstveit and Hveem, Oil in the Gulf: Obstacles to Democracy and Development, (Aldershot : Ashgate, 2004), p22. Data does not include Bahrain and Oman.





The data above (fig. 3) show that while the value of oil produced daily has dramatically increased since 1970, the value per capita (the value of oil produced per person in the national population) has fallen. Although uncertain oil prices play a significant role in that value, and are determined by international supply and demand, the resultant income is nonetheless spread among the population, which, having grown dramatically, has been the determining factor in substantially reducing the per capita oil value. This denotes that not only does high population growth present an expensive opportunity cost, but also that expected continued population growth will overwhelm oil production value in the future, causing a drop in living standards, unless there is a sustained considerable oil price increase. Overall, the data indicates that living standards will fall considerably if oil remains the major income generator in the Gulf. This is the basic problem facing the Gulf countries. Replacing that income with durable private jobs is the solution.

Labour Markets in the Gulf
The task of developing sufficient private sector jobs is not unrealistic for the region. A recent World Bank reports says that if only half of the MENA region’s trade and private investment potential were realized over the next 10 years, per capita GDP growth would suffice to meet the growth in jobs required in the entire region in the coming decade, both in absorbing new entrants to the labour force and the existing unemployed[6]. The bulk of that investment is already happening in the Gulf.
Because the governments have traditionally been the major employer, the private sector is comparatively small, substantially occupied by non-nationals (see fig. 4) and produces very little for export. This situation is unsustainable. The ratio of nationals working in the public sector compared to the private sector is considered high: almost 90% in Qatar in 2007, 86% in the UAE, 84% in Kuwait and 50% in Saudi Arabia[7]. These figures suggest that the public sector absorbs large amounts of government spending, is saturated, and unable to continue absorbing new entrants. Bahrain revealed in 2009 that it is the limiting new employment in its public sector.



Fig 4. Source: College of Business and Economics, United Arab Emirates University               <http://newsletter.cbe.uaeu.ac.ae/images/clip_image002_0000.gif> (accessed Apr. 2010)







The GCC states have nationalization programs to replace expatriates with nationals in key jobs. However, as long as the labour markets remain so open to foreign labour, nationals will not be able to compete with more productive and cheaper foreign labour. Companies can import the cheapest possible labour rather than employ and invest in the local labour force. This means high skilled as well as unskilled jobs are often taken by foreigners.  The Gulf governments should deter excessive foreign labour by tightening immigration policies and taxing companies that hire foreigners, thus forcing companies to rely on, and train the local work force, thereby increasing local knowledge, competence and productivity. The public sector must also become less attractive to nationals. At present, public sector jobs enjoy salaries up to 25% higher than equivalent private jobs, along with numerous other benefits. Remuneration should instead be pegged to productivity so that firms operate at competitive market costs, and nationals are convinced of the benefits of the private sector.

Education and Human Development
Gulf nationals need to understand that employment in market economies is linked to levels of education and training and that if they do not possess qualifications, menial jobs are a dignified choice for them. In this regard, improvements in educational standards and training opportunities are vital. As previously shown, around a half of the Gulf population is of school age, meaning the region faces a ‘demographic dividend’ if large amounts of skilled people shortly become active in the labour. The demographics of the region could therefore be an important economic opportunity if education is of a high quality.
Educational Curricula need to be more aligned to the demands of modern economies and that includes vocational subjects. Improved education and training must remain a priority in the Gulf for nationals to participate in the international economy. The Arab Knowledge Report 2009: Towards Productive Intercommunication for Knowledge notes that despite the progress made in Arab research and innovation in recent years, R&D institutions are weakly integrated into the production cycle, meaning that practical application in business settings is missing. Utilizing Oil Investment Funds for improving education is fundamental to the development strategy of the Gulf since investment in education (human capital) outperforms any other investment over time[1].

Developing the Private Sector
The governments can encourage private sector growth by a number of policies. These include privatization of state assets including the oil companies. Privatization increases the efficiency of companies and ultimately makes them more competitive in the global market. The integrating effects of globalization over the last two decades means the Gulf economies are exposed to competition from other emerging economies such as China and must therefore optimize efficiency.
Public enterprises often over-employ to provide jobs, although this adds unnecessary costs that make those companies uncompetitive. They must privatize and make efficiency savings that may involve reducing staff numbers, causing short term unemployment. Yet the added productivity will create sustainable jobs over time as companies gain market share domestically and internationally due to added competitiveness. The Gulf States started with no manufacturing base, but the example of the UAE illustrates how exports can be widened beyond oil, starting with related downstream industries. Domestically produced petrochemicals added value to oil exports as did the transition to other energy intensive industries such as fertilizers, cement and metals. These industries are suitable for the Gulf States. Additional businesses are drawn in (regionally or from abroad) to service the broader manufacturing base, bringing foreign direct investment (FDI) and knowledge which foster more investment. 
In Norway, the authorities ensured the growth of local servicing industries in its oil diversification experience[2] by obliging foreign petroleum companies to use local private companies and products when competitive. The Emirates Centre for Strategic Studies and Research notes that although international oil companies are reluctant to train locals for top jobs, in Norway they were compelled to do so under short term protectionist knowledge-transfer measures in order to boost the skills and knowledge of nationals to prepare them to take over from foreign operators. By 1994, 70% of Norwegian content in its oil industry was secured by local companies which became world leaders in their fields. In comparison, many Gulf States remain largely stuck in extraction activities[3]. The policy used in Norway guaranteed optimal revenue retention whilst developing its own industries. The Gulf States could likewise use short term protectionist measures to develop infant industries until they gain market share and experience and are ready for private sector exposure.

Exports
In Abu Dhabi non-oil exports already contribute about 40 percent to the gross domestic product and are predicted to rise to 50 percent by 2015 and 60 percent by 2025[4]. The growth has been led by heavy investment through state-run Oil Funds in joint ventures which take advantage of foreign expertise.
A negative characteristic of mineral exporting countries is that they suffer from inflated currency valuations (‘Dutch disease’) due to sudden influxes of foreign exchange, and the excessive consumption of non-tradables. The resultant overvalued exchange rate makes non-oil exports expensive while imports become cheaper. This means export manufacturing is inefficient in the absence of careful macroeconomic policy. Oil Stabilization Funds can help offset the vagaries of oil price fluctuations, spreading risk and sustaining public spending during periods of low oil prices. Oil wealth can also support the manufacturing base by purchasing technology or expertise from abroad, for example through Oil Investment Funds. Investing current account surpluses abroad and devaluing the currency help keep exports competitively priced by reducing domestic inflation.
 The integration of the Gulf States into the GCC union affords many benefits in manufacturing and export potential. A single Gulf currency would help stabilize regional macroeconomic variables and introduce economies of scale and larger markets conducive to growth and synergy. The region must however coordinate more effectively in building infrastructure. It is not reasonable for every Emirate to have an airport and stock exchange or for each state to produce its own cement as this shrinks market potential for profits and encourages protectionism.

The State
Many obstacles to development in the Gulf are political in nature, or cannot be confronted apart from political reform. There is a correlation between the lack of political reform and poor economic performance.
The Gulf States suffer corruption and inefficiency because transparency is lacking.  The Abu Dhabi Investment Authority (the largest Investment authority in the world with estimated assets of $627 billion) has a transparency rating of just 3 out of 10, whilst its Norwegian counterpart is the most transparent oil fund[12]. The poor transparency of the Gulf Oil Funds is a direct result of the rent-seeking behaviour promoted by deficient accountability. Until GCC leaders are made accountable through political liberalization, they will continue to use the oil funds as their private capital. In this and many other regards, political liberalization remains the enabling factor for realizing optimal investment of oil revenues.

The phenomenon of rentier state behaviour is not exclusive to the Middle East but occurs in many countries where minerals such as oil tend to cause political centralization within the state which subsequently acts to monopolizes wealth to secure power for those who hold it. While the West has been somewhat responsible for maintaining the rentier state in the Middle East (Moïsi 2001)[13], the contemporary developments are unique in that pressure for reform is now exogenous since the population growth and unemployment are internal issues and pressure will come from below.
Because the need for political reforms will become more pertinent as oil resources decline, a move towards political reform is the inevitable development strategy of the Gulf. The governments will lose credibility when they are no longer able to supply subsidized goods and limited taxation. The loss of such benefits must be substituted with gradual greater political representation for the people. To implement this, the Gulf leaders must relax subsidies and introduce taxation followed by increased public participation in the political process. If political concessions are not forthcoming, it is likely that civil unrest will occur as oil value per capita falls to low levels, causing substantial decreases in living standards and making the rentier model ineffective. Reforms can nonetheless be implemented gradually to minimize the negative outcomes of reducing the public sector. There will likely be social resistance to reform from those who stand to lose the most from liberalization such as those with favourable business relationships with the government and those employed by the state. Maintaining subsidies but at a lower rate, and gradual introduction of taxation will limit this.

Conclusion

The extent that political power is transferred away from the governments will determine the success of the economic reforms now taking place. If the private sector does not gain influence, it will not gain the necessary features such as independence from political favours, transparency, access to capital and a business friendly environment that are a prerequisite of successful economies. As one commentator notes, ‘Economic restructuring away from oil is urgent, but success will depend on political power shifting from the state to the private sector, and from the rulers to the ruled’[14].

 As demonstrated in this essay, high resource endowment presents its own economic and political challenges which cannot be surmounted without effective and transparent governance. Good governance is vital in the reform process since it removes any agenda that may impede positive change.

The willingness of Gulf leaders to make reforms to encourage investment will depend on how large the benefits of that investment will be. In addition, investors must believe that those reforms are credible enough so that the leaders can be held accountable to their promises to refrain from interventionism. As the mechanisms for accountability become stronger, the oil rents available to the leaders from the economy decreases. For leaders that maintain support from distributing oil rents, forgoing support by giving more power to private businesses will inevitably mean risking their political dominance whilst giving up large amounts of their financial base. Democratic rule will inevitably follow, supporting greater reform.

The opportunities for the Gulf are immense. It has witnessed unprecedented social and economic change over the last three decades, although non-oil growth has until recently remained weak. It is up to the political leadership, local business leaders and the public to recognize that whilst private sector-led growth remains the major challenge for the Gulf, it is its most favourable development strategy. With unprecedented oil wealth predicted in the next two decades, the region will find that it is well positioned budgetary-wise to reform compared to the rest of the Middle East. The leadership must, however, commit to complete political reform in the longer term in order for economic reforms to materialize effectively enough to cater for the growing population.




Notes

[1] The Gulf countries include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.  These form the Gulf Cooperation Council (GCC). The terms ‘Gulf (states)’ and ‘GCC’ are used interchangeably in this essay. 
[2] The Emirates Centre for Strategic Studies and Research, The Gulf Oil and Gas Sector, Potentials and Constraints, (Abu Dhabi: Emirates Centre for Strategic Studies and Research, 2006), p56.
[3] Whilst data used in this essay are from credible sources, economists recognize that information from the region is not always accurate or reliable, and this limitation should be considered when appraising such data.
[4] The World Bank, Trade, Investment, and Development in the Middle East and North Africa: Engaging with the World, (Washington, D.C. : World Bank, 2003), p1. Also Richards & Waterbury, A Political Economy of the Middle East, (Boulder, Colo. : Westview Press, 2008),  p86.
[5] Richards & Waterbury, p72
[6] The World Bank, p4
[7]National Bank of Kuwait, GCC Brief 17 February 2009, 2009
[8] Stan Davis, ‘Building the knowledge-based Economy: Challenges and Opportunities’, in Human Resource Development in a Knowledge-Based Economy, (Abu Dhabi: The Emirates Centre for Strategic Studies and Research, 2003) p33-60
[9] Øystein Noreng  in The Gulf Oil and Gas Sector, Potentials and Constraints, (Abu Dhabi: Emirates Centre for Strategic Studies and Research, 2006), Ch 5.
[10] Ibid. p176-184.
[11] Christopher M. Davidson, Abu Dhabi: oil and beyond, (London : Hurst, 2009), p40.
[12] The Sovereign Wealth Fund Institute, <http://www.swfinstitute.org/funds.php > (accessed Apr. 2010).
[13] Heradstveit and Hveem, p10.
[14] Ibid, p11.







Sources

Alissa, Sufyan, The Challenge of Economic Reform in the Arab World:Toward more Productive Economies, (Beirut: Carnegie Middle East Center, Carnegie Endowment for International Peace, 2007)

Askari, Hossein, Economic development in the GCC: The Blessing and the Curse of Oil, (Greenwich, Conn. : JAI Press, 1997)

de Boer, Kito and Turner, John M, The Mckinsey Quarterly: Beyond Oil: Reappraising the Gulf States, (Mckinsey & Company, 2007)

Davidson, Christopher M., Abu Dhabi: oil and beyond, (London: Hurst, 2009)

Davis, Stan, ‘Building the knowledge-based Economy: Challenges and Opportunities’, in Human Resource Development in a Knowledge-Based Economy, (Abu Dhabi: The Emirates Centre for Strategic Studies and Research, 2003)

Dasgupta, Dipak and Nabli, Mustapha Kamel, Trade, Investment, and Development in the Middle East and North Africa: Engaging with the World, (Washington, D.C.: World Bank, 2003)

Heradstveit, Daniel and Hveem, Helge, Oil in the Gulf: Obstacles to Democracy and Development, (Aldershot: Ashgate, 2004)

Najy, Benhassine, From privilege to Competition: Unlocking Private-Led Growth in the Middle East and North Africa, Mena development report, (Washington D.C.: World Bank, 2009)

Richards & Waterbury, A Political Economy of the Middle East, (Boulder, Colo. : Westview Press, 2008).

College of Business and Economics, United Arab Emirates University               <http://newsletter.cbe.uaeu.ac.ae/images/clip_image002_0000.gif> (accessed Apr. 2010)

The Emirates Centre for Strategic Studies and Research, The Gulf Oil and Gas Sector, Potentials and Constraints, (Abu Dhabi: Emirates Centre for Strategic Studies and Research, 2006)

National Bank of Kuwait, GCC Brief 17 February 2009, 2009

The Sovereign Wealth Fund Institute, <http://www.swfinstitute.org/funds.php > (accessed Apr. 2010).

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