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Looking beyond oil

While the current oil boom presents an ideal opportunity for the GCC countries to initiate and fund a range of economic diversification measures, it is equally true that when the oil price is high, there is a tendency to maintain the status quo and delay reform.

The hydrocarbons sector is the single largest contributor to the GDP for all the GCC countries, something which has remained unchanged for many years. Ironically, the oil price boom has somewhat skewed and masked recent diversification efforts. Last year, in all but one state, oil had actually increased as a percentage of overall exports as compared to 1994.

With the exception of the UAE, which has substantial oil reserves and has been particularly successful in diversifying its economy, there appears to be a correlation between the life expectancy of a given country’s oil reserves and its degree of economic diversification. Bahrain has by far the lowest oil reserves, which at current production levels are only expected to last a few more years. Bahrain is the most liberalised and economically diversified regional country, and is ranked as the ‘most free’ of all GCC countries in the Heritage Foundation Index of Economic Freedom.

Oman has the second lowest reserves, forcing its government to privatise some state-owned assets, pass laws for 100 per cent foreign ownership of certain companies and invest heavily in the tourism and hospitality sectors. ‘Vision 2020’ is a government initiative which aims to diversify the economy completely away from oil over the next 15 years.

At the other end of the spectrum are Kuwait and Qatar that have huge hydrocarbons reserves and relatively small populations. For them the imperative to diversify is not as acute and the contributions that oil and gas makes to their GDPs are by far the highest in the region —46.6 per cent and 62.2 per cent respectively. This correlation demonstrates that diversification is achievable economically, but also requires concerted political determination.

In Saudi Arabia, the problem is not one of dwindling supplies. The kingdom has the largest share of the world’s proven oil reserves as well as some of the lowest extraction-to-market costs anywhere in the world. With one of the highest growth rates in the world, the problem is a rapidly growing population, and the increasing levels of unemployment associated with it. The oil industry is capital intensive and cannot absorb more than a small percentage of the young Saudis that enter the labour market annually. Since the current oil boom, it has invested heavily in down-stream activities.

For instance, a huge downstream project, worth about $4 billion is being developed at Rabigh —the integrated refinery and massive petrochemical complex will produce both high-end refined products and petrochemicals. Interestingly, a foreign company, Sumitomo of Japan, will be working jointly with Saudi Aramco. However, years and in some cases decades after announcing economic diversification policies, most GCC countries remain highly dependent on oil revenues. Leaving aside the fact that, as a finite commodity, the region’s oil and gas reserves will eventually be exhausted, there are many short-term problems associated with dependence on oil. The price of oil is inherently volatile and as government income —a prime economic driver —largely depends upon it, the region is particularly vulnerable to periods of boom and bust and large cyclical swings. In particular, this creates difficulties in fiscal spending commitments, as well as economic and budgetary planning.

Another problem is that the oil and gas sector is capital intensive and as such generates little employment, something that is badly needed within the GCC countries since around 40 per cent of the population is less than 15 years of age and unemployment levels are increasing. Further, another hitch associated with oil exports is ‘Dutch disease’, where it is often cheaper to import manufactured goods as opposed to producing them domestically. This means that various products, if manufactured locally, will be less competitive and, as a consequence, generating employment in the manufacturing sector is limited.

There are indications, however, that serious attempts are now being made to diversify away from oil dependence, especially relying on export earnings derived from crude export. It must also be remembered that the current oil price and production boom has distorted the modest successes of diversification policies to date. An innovative way of diversification could be through foreign asset acquisition. The UAE recently purchased a 10 per cent equity stake in German carmaker Volkswagen; in return the company will set up an assembly plant in Abu Dhabi and consider purchasing GCC produced components.

The GCC will for the foreseeable future have a comparative advantage in down-stream petrochemical industries and industries that need a high level of energy input such as aluminum production. Diversification efforts should initially be directed toward such industries, but as they tend to be capital as opposed to labour intensive, they cannot address the region’s current economic challenges on their own. Once the GCC’s comparative advantages have been capitalised, a concerted effort at generating jobs in the service sector needs to be undertaken —Bahrain and Dubai provide excellent examples and it is no coincidence that both have limited oil reserves.

The GCC’s integration efforts are a key part of the diversification process by creating a single market and working towards a single currency should enhance non-oil trade and attract greater levels of FDI overall.

The stagnation of the GCC economies during the 1990s should serve as a reminder that high oil prices are not guaranteed. To push ahead with bold diversification plans now —while government revenues and surpluses are at all-time highs —could well reduce the pain of future oil price reductions and deal with future unemployment problems before they become critical. Now is a good time to make the necessary structural and regulatory reforms in order to diversify the region’s economic base. To sit back and do nothing in this respect would be to jeopardise all of the phenomenal growth and achievements the region has witnessed over the past few years.

The author is an economic researcher at the Gulf Research Center, Dubai.