Saturday, 16 April 2011

Does oil hinder economic development in the Middle East?

Oil- a blessing or a curse?

The presence of oil in the Middle East has undoubtedly brought large benefits in terms of capital surpluses to the region. However without effective and considered usage of these revenues, the region will not achieve sustainable economic development.  The permanent generation of income can only be secured by development objectives that reduce reliance on oil export revenues by careful utilisation of the income produced by oil. Because oil is depletable, it does not constitute sustainable growth. However, oil revenues can be investment in economic activities that do produce sustainable development and growth. In the last few years, Gulf states have sought to invest in sectors such as education and tourism in a bid to diversify their economies. In other words, they have recognized the significant need to reduce dependence on oil income.

The windfall revenues of the 1970s were effective in spurring development through investment in infrastructure including hospitals and schools. Although unprecedented development projects resulted, they became dependant on the volatile state of the oil market. Furthermore, much potential was wasted on prestige projects, misinformed development objectives and overtly high military expenditure. The fact that future reserves as well as access to foreign labour and western technical assistance had to be secured for continued maintenance of the new infrastructure shows that ‘infrastructure development cannot in every case be interpreted as laying a sound base for future economic and social progress’[1]. In other words such projects require the continual diversion of future oil revenues, which could be spent on other development goals such as industrialisation, which is a permanent income generating economic structure. The influx of wealth during periods of high oil prices is difficult to absorb in the oil states and results in inefficient investments and expenditure on large public sector firms, many of which do not stimulate income efficiently. It would be wiser to spread larger amounts of surplus wealth on investments abroad according to the Norwegian example.

lofty ambitions

Oil has been successful in achieving development in that expenditure of reserves in Western economies (such as Kuwait’s large investments through its national funds) has at least tied the Arab economies to the global economy.  Foreign investment where risk is low and the returns high, is recommended for the GCC states, where the small population and absence of other resources makes diverse industrialisation difficult to attain. The depletion of oil requires adequate compensation by savings, i.e. investments which act as productive assets for future generations. Sovereign Wealth Funds (SWFs) achieve this result whilst also relieving inflation when oil profits rise during periods of high demand. Domestic investments, on the other hand, must be channelled through the private sector to create growth. The inefficiency and small size of the private sector in the Arab oil producers has meant the dominance and over reliance on the fluctuating oil wealth. According to Askari, “oil has made the neglect of the private sector growth possible”.

The effects of ‘Dutch disease’ make export manufacturing inefficient in the oil economies, but careful macroeconomic policy is able to build a manufacturing base which can be supported by oil wealth.
The ruling families of the GCC have not made enough political and economic reforms for diversification. The flow of oil revenues makes it less compelling for them to make such reforms and they have enough wealth inflow to sustain their rule and the absence of taxation makes the rentier state unaccountable to the public, who themselves are satisfied by above market salaries from the large public sector. Growth of the private sector would bring real market conditions to these states and integrate them further into the world economy and less on oil. The oil wealth should be used as capital to invest in such activities.

Future development strategies require long term perspectives that might not necessarily secure immediate cash windfalls, but will nonetheless introduce continued stability and funds conducive to development aims.

Qatar Science and Technology Park. Innovation must
stimulate economic growth in the region

The presence of large oil deposits in the Middle East does not necessarily mean the hindering of economic growth as long as prudent investments are combined with sensible policies. Richards and Waterbury comment that the larger oil producing states with large populations such as Iraq, Algeria and Saudi Arabia have the possibility of industrialisation but remain restricted by ‘political disabilities’. As for the smaller states such as the UAE and Qatar, sustained economic growth through overseas investments is recommended. Syria, Jordan and Tunisia must concentrate on human capital and exports of skill-intensive manufacturing. In order to decrease the negative effect of oil on development, large savings and investments must be made on the incoming oil wealth for the benefit of future generations.

A stabilization fund can be employed to alleviate the negative effects of fluctuations on the oil markets and allow long term development objectives that would otherwise be subject to fluctuations on the oil markets.

Overall, oil wealth is highly beneficial to economic growth if utilized for considered development objectives towards sustainable growth. Policies in the region have historically been ineffective in developing industrialisation and the private sector although diversification is now a development objective in many states. Limited political participation remains an obstacle to sustainable economic development.

[1] Findlay, Allan M Arab oil and the use of oil revenues, The Arab World p90

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