Gulf Industrialization in Perspective

Gulf Industrialization in Perspective

Hazem El Beblawi

Introduction:

The term “the Gulf Countries” refers to the Arab States Members of the Gulf Cooperation Council, GCC (Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and the United Arab Emirates “UAE”). With the exception of Bahrain and Oman, the other GCC countries are major oil (and gas) producers. Oman and Bahrain have modest oil resources. Saudi Arabia is the largest economy in the region representing about 50% of the combined GDP of the GCC countries, some 80% of the total area, 70% of its population and holding about 55% of its proven oil resources. Moreover, as host to the Holy Islamic Shrines, Saudi Arabia enjoys a traditional cultural influence within the region. The Saudi prominence notwithstanding, some small principalities, particularly Dubai in the UAE, exhibit vibrant dynamism as a booming real estate market and a hub for trade and services. Qatar also aspires to play a more visible role. Its outspoken Al Jazeera Television is indicative in this respect.

GCC countries are not only oil producing countries; they also share among themselves the special characteristic of heavily relying on imported labour. The percentage of expatriates to total population reaches as high as 80% of the population or more in the UAE, the lowest level of foreigners is around 20% in Oman. Non-renewable oil resources and imported labour are the two main economic features of GCC countries. Thanks to the abundance of the oil and the low population density, the GCC countries enjoy high per capita income. In fact, some countries in the region rank among the highest per capita worldwide.

Over the last three or four decades, most countries in the region have invested lavishly on large and high quality physical infrastructure projects (roads, ports, airports, electricity, schools, hospitals, etc). No less generous were governments’ expenditures on social welfare. The governments of the GCC provide their citizens with a wide range of free or low cost services (water, housing, education, health care  ...etc). Life expectancy in the GCC Countries increased by almost 10 years to 74 years during 1980-2000, and literacy rates increased by 20 percent over the same period. Overall, real economic growth has averaged 4 percent annually, during the last three decades. (Ugo Fasano  and Zubair Iqbal, GCC Countries: from oil dependence to Diversifications, IMF, 2003). Moreover, GCC citizens benefit from the rare privilege of no taxes or very low- tax rates.

Nothing disrupts this peaceful and soft existence except the extremely hot weather and the uncertainty regarding the future. In some places, though by no means in all, a third element of social discontent is added to the list of national worries. As for the weather which can reach some 50 degrees Celsius in summer, indoor air-conditioning can help. For social or political discontent, whenever it exists, the Arab solution is usually a blend of the stick and the carrot approach, involving some repression coupled with a measure of governmental largesse. As for the future, or preparing for a post-oil area, the Gulf states hope that a policy of economic diversification would be the appropriate response.

It is within this last perspective that we shall discuss the issue of the Gulf industrialization. To what extent does the industrialization in the Gulf help the region to survive in a post- oil era? Inevitably the discussion cannot be confined to the manufacturing industries in the narrow sense.

Main Features of The Industry in The Gulf:

We do not intend to undertake a detailed analysis of the Gulf industrialization experience. The purpose of the paper is to bring to light the major challenges facing the Gulf industrialization model.

The Gulf economies, as previously mentioned, are dominated by oil. It is therefore no surprise, that “Ores and Minerals” and the “Government” sectors, represent more than half of the GDP in the Gulf countries.

Table I

GDP by Sector in the Gulf,  %

Source: Arab Joint Economic Report, Arab Monetary Fund, 2006

 The “Ores and Minerals” sector is mainly oil and gas production. As for the “manufactures”, they are basically divided between oil-based and import substitution industries. The oil-based industries include, in addition to the extraction of oil and gas (Ores & Minerals), the oil processing refineries, the petro chemicals as well as the energy-intensive industries such as aluminum. Oil refineries in the Arab World represent about 9% of the total world capacity, half of which are in the Gulf area. Saudi Arabia has established two industrial zones for petrochemicals, one in Yanbou on the Red Sea, and the second is in Jubayl on the Persian Gulf. Aluminum is produced in Bahrain and UAE. Qatar has embarked on the establishment of another huge Aluminum project, Oman is following suit.

Oil-based industries are usually huge projects, very modern and highly capital- intensive. They are also basically export-oriented and enjoy clear high comparative advantage due to the low cost of oil production in the region.  They are a gift from nature, turning the region into one of the most conspicuous rentier  economies in the world, thus affecting the general pattern of economic behavior and the comparative advantage of other potential sectors (Dutch Disease), as we shall see. 

Outside oil and gas, manufacturing industries are import-substitution, mainly in the areas of food processing and construction materials. In the food processing sector, the local industry relies heavily on imported components. Some major international brands find it more expedient to franchise or to form joint ventures with local investors to process their products locally and thus maintain their market share. The local value-added in food processing industries is therefore modest.  This is not the case regarding the local industries in the construction sector. Cement industries, in particular, use local materials and thus have reasonably high local content and value-added. The production of cement has increased substantially in the GCC countries and there are plans to further increase capacities in the near futures. It seems thus that independently from the oil, the region enjoys a relative comparative advantage in the cement industry. It has to be mentioned here, however, that many industrial countries in the West are encouraging the migration of their cement industries because of environmental reasons. The economic benefits from these industries, are, thus, counter-balanced in the Gulf by high environmental costs.

Table II

 Productive Capacity of Gulf Cement Industries

Source: the Arab Joint Economic Report. The Arab Monetary Fund 2006.

What are the prospects of these local industries in the post-oil era?

As for the oil-based industries, their future is organically dependant on the availability of oil. They have no future beyond the oil era. However, it would be a mistake to think that oil will cease to exist suddenly. It will, in fact, be gradually phased out over a long period. Most probably, other alternative sources of energy would increasingly replace oil. Oil will continue, nonetheless, to be used as a valuable raw material for petrochemical industries, which would thus have a much longer span of life.

As for other import substitution industries, they have very little prospects to expand substantially beyond the needs of the local markets. They hardly enjoy any clear comparative advantage with modest levels of local value-added.

It is, thus, clear that neither oil-based nor import substitution industries have much hope to survive or to expand in a post oil era. This is a very long-term perspective, but it necessitates the adoption of a strategic vision. Does this mean that the Gulf countries have failed, so far, to develop a viable industrialization model for the post-oil era? And if so, why?

We have characterized the Gulf economies as basically oil-based and heavily dependant on imported labour. These two aspects help explain the above conclusion. 

Resource- Based Economies

There is a rich literature on resource-based economies. While the initial thinking was that abundant natural resource endowment is a blessing, the more recent writings on the subject emphasize the contrary, i.e. the negative aspects of resource –based economies. This is usually labeled the “curse of natural resources”. The truth is perhaps between these two extremes. Natural resources are neither a pure blessing nor an absolute curse; they could be a definite bonus provided they are well managed.

The negative aspects of resource-based economies could result from a psychological mind-set associated with non earned incomes and/or an economic distortion of prices, thus disrupting the proper allocation of resources. Resource-based economies could, in fact, favour a rentier mentality behavior and/or disrupt the proper allocation of resources.

The author of this paper has discussed, in another context, the concept of the rentier state (Hazem Beblawi, Giacomo Luciano, The Rentier State, Crome Helm, London, 1984). A rentier mentality is incompatible with hard work, discipline, risk-taking…etc. This mentality embodies a disconnect in the work-reward causation. This would need no further elaboration here. However, I would emphasize the other negative aspect which is related to the distortion of resources usually known as the concept of the “Dutch Disease”. This syndrome was first detected in Netherlands subsequent to the discovery, in that country, of natural gas and the accompanied windfall wealth that followed.

This concept was first introduced in 1982 in a paper by Max Cordon and Peter Neary. The authors of the concept divided the economy experiencing such a syndrome into three sectors. Two sectors of traded goods; the first exporting the booming natural resources, and the second exporting other manufacturing goods. A third sector is defined to cover the non-tradable goods. The essence of the argument, is that the booming resource-based sector will bring about a surge in foreign exchange earnings in such a magnitude as to appreciate the local currency. This appreciation can be the result of general price increase and/or a change in the exchange rate, according to whether the country is following a gold standard or a flexible exchange rate. This appreciation of the exchange rate would penalize other exporting industries and undermine any potential comparative advantage in the rest of the economy. The benefits of the resource-based sector would thus be effect by foregoing opportunities for developing further potential comparative advantages. As such, the economy would deepen its reliance on the resource-based industry and deny itself the possibility of developing otherwise competitive industries. A resource-based economy is not always a blessing. If not well- managed, it can become a curse.

The drama for the Gulf States is that oil is not simply another economic activity added to other existing productive sources within a viable and modern economy, as is the case with the Netherlands or for that matter Canada, Australia and the Scandinavian countries. In the Gulf, the oil sector dominates the rest of the economy. It is almost the unique source of wealth. Oil was discovered in these countries at the very start of their nation building. Considerations of nation- building would naturally overtake other considerations of economic management of assets. Of course, these countries needed to diversify their economies to survive in a post-oil era. Oil-based and /or import substitution industries do not seem, however, to be the required kind of diversification needed for such a purpose. The question, then, remains valid as to why oil-based and import substitution industries were established in the first place?  There must be something wrong, what is it?

The Original Sin, The Fallacy of National Accounts:

The distinction between “income” and “capital” is fundamental to basic economics. Income is a flow concept; it is the recurring flow of goods and services over a period of time. Income is used to satisfy its earner’s needs, both present and future. Income is, thus, used for consumption and savings. Capital, on the contrary, is a stock concept, it is the wealth or assets that exist at a certain moment, and its function is to generate income in the future. The capital owner has the obligation to conserve the value of his capital and to put it into a wise use to generate income in perpetuity. From an accounting point of view, income is captured in the income statement at the micro level and is an element of the GDP at the macro level. Capital, on the other hand, is a balance sheet item. These elementary economies principles have been partially ignored in the case of the Gulf States as to how to treat the oil proceeds. They simply considered the oil receipts as income. As their incomes increased substantially following oil price increases, the Gulf-States have behaved like rich countries and enormously have increased their consumption. The huge inflow of foreign exchange and the price structure that followed were taken for granted as a proper indication for resource allocation. Oil prices, thus, have dominated the economy giving rise to a generalized Dutch Disease.

The truth of the matter is that the Gulf countries possess a finite quantity of underground oil. These are neither recurrent nor renewable flows. They are real assets and should, thus, be conserved like any other capital asset. Pumping oil and selling it on the market is no more than transforming a real underground asset into financial assets. Oil production is no more than the monetization of oil into monetary capital. Managing these financial assets should be no different from any asset management. The conservation of the value of oil proceeds can be achieved through investing them in capital formation whether, physical, portfolio and/or human capital. The proper mix between physical, portfolio and human capital formation can differ according to places and times.

The perception of the true nature of oil proceeds was, however, realized in various other countries. Norway is a pioneering example in this respect. The third largest oil exporter, behind Saudi Arabia and Russia, Norway has realized, after some painful experiences, the need to neutralize the impact of oil proceeds on the rest of the economy. The Norwegians have, thus, passed a legislation requiring that almost all the revenues from the government-owned oil company, Statoil, be placed in an “investment fund” to ensure that oil and gas receipts will not distort the price structure and will benefit future generations. As such, the Norwegian economy succeeded in insulating itself, to a large extent, from the “oil curse”, and ensured that actual consumption was confined within the boundaries of the productive capacity of the economy.

The Gulf States did not follow this path. Oil proceeds are still included in their GDP and constitute the principal revenue of the government budget. However, most Gulf States, after an initial period of nation-building, have adopted conscious policies to allocate a portion of the oil revenues to investments funds for future generations.

Gulf Investment Funds:

Though the Gulf States did not subscribe completely to the idea that oil proceeds are wealth rather than income, they were, nevertheless, aware of the fact that oil proceeds are temporary gifts from nature and that they need to build a viable diversified economy. It is also worth mentioning that, contrary to Western oil producing countries- UK and Norway- oil was discovered in the Gulf at a time when the majority of the populations were living in a pre-industrial phase. Mostly, they were very poor nomadic tribes, sparsely populated, constantly moving from one place to another for pasturage. Settled populations were the exception rather than the norm. Faced with such situations, the first responsibility for the newly independent states was, inevitably, nation-building. Spending on physical infrastructures, providing basic services to the population was the prime concern of the newly established States. It is no wonder, then, that nation-building took precedence over other considerations.

It was Kuwait, which first envisaged investment in foreign financial markets as a strategy to diversify the economy. The Kuwait Investment Office was, thus, opened in London, 1953 to this purpose. After three decades from the oil discovery, the Gulf governments’ strategies started to give heed to responsible and future-looking management of the oil proceeds. In the mid seventies, Kuwait established an Investment Fund for Future Generations (IFFG).  This fund is kept outside the government budget.

The Kuwaiti approach, as adopted, was a pragmatic compromise. It did not go as far as to consider oil proceeds as capital assets. Oil proceeds, in the Kuwaiti national accounts are still included in the Kuwaiti GDP. The government, however, made a point to set aside part of these proceeds in a capital account not to be touched for current expenditures. The returns on these investments were to be reploughed back in the same account. These returns are not to be included in the government budget revenues. The government is not allowed to draw on these funds except in exceptional cases and with special authorizations from the parliament.  The financial resources that have thus been put aside proved to be extremely helpful for the Kuwaiti government during the Iraqi invasion in the early 1990’s.

Over and above this Investment Fund for Future Generations, the Kuwaiti government established a number of semi-governmental investment entities to invest in various sectors inside and outside Kuwait, the most well known among these institutions is the Kuwait Investment Authority (KIA), with assets exceeding now, $200 billions. The investment portfolio has, thus, provided Kuwait with handsome returns in amounts that in some years matched the oil proceeds. Nevertheless, the Iraqi invasion of Kuwait and the subsequent costs of reconstruction have depleted a good portion of these funds. On the other hand the increase in oil prices in the last few years helped replenish them again. At present, it cannot be said that Kuwait is completely dependant on oil revenues. Portfolio investment income is becoming equally important to Kuwait and to a lesser degree to other Gulf States. Most other Gulf States have, in fact, followed the example of Kuwait, thus, establishing their investment authorities and semi-governmental and private investment companies. Abu Dhabi (UAE) is probably the first to follow the Kuwaiti example, establishing its Investment Authority in 1976, which became the largest sovereign fund with total assets now reaching some $ 875 billions. Dubai, also in the UAE, established its own Fund in 2004, and Qatar followed in 2005. (The economist, Jan. 19, 2008).

These financial institutions have become major players in the international capital markets. During the recent bank subprime crisis, the Gulf investment funds have actively participated in rescue packages for many of the troubled banks. Kuwait Investment Authority (KIA) which invested as much as $ 3 billions in Citigroup is considering another $4 billion in a capital increase for Merrill Lynch. Abu Dhabi Investment Authority also participated in Citigroup financing with some $2.5 billions in late 2007. UBS, the Swiss investment bank, also benefited from Gulf financing during the same crisis.

The Gulf States seem to have realized that their real comparative advantage does not reside in oil per se but rather in their accumulated liquid functional assets. They all have the prerequisites to play a major role as international financiers.

If this is correct, then the question that arises is whether a country can solely live on the returns of their portfolio investments? History tells us that most international financier centers were usually backed by political, military and/or economic powers. Finance alone is too vulnerable. London or New York were backed by strong economic and military empires. Amersterdam in the 17-18^th centuries benefited from a strong maritime force. Even Italian medieval cities such as Venice, or Genoa possessed strong armies and naval powers. Perhaps, the Vatican is the only financial power without a strong army, but it is backed by the larger global community of faithful adherents and strong moral authority.

It has been argued in some quarters in Europe and the USA that Sovereign Wealth Funds are politically motivated and thus can create security risks and that, more often than not, these funds are not transparent. Based on such allegations the American authorities have, recently, rejected the purchase by Dubai Port Authority of a British company (P&O) that serviced a number of U.S ports. Two decades earlier, the British government (Thatcher), forced the Kuwait Investment Office to sell more than half of their assets in British Petroleum. More recently some European politicians, French President Sarkozy being one, indicated their hostility to these sovereign funds.

Present debate on these Sovereign Wealth Funds casts some doubt on the possibility of relying safely on financial investment as a unique source of income in a post-oil era.

Dubai Exceptionalism:

Dubai is one of the seven emirates that constitute the UAE. Abu Dhabi, the capital, is the largest and by far the major oil producer in the UAE with large oil reserves. Dubai’s gross domestic product is estimated at $ 46 billions, in 2006, of which less than 6% is derived from oil and gas. With a population of some 1.5 million, it enjoys one of the highest per capita incomes in the Gulf, around $ 30.000. Not only does Dubai have modest oil revenues but the life span of its oil reserves is no more than 20 years or so.

Despite its relatively smaller oil and gas resources, Dubai is among the fastest growing economies in the region. The economic performance of Dubai over the last few years has been impressive and the prospects for further growth seem very promising. Dubai has been growing at a sustained rate of 10-13% over the last decade or so.

How did this happen? Could this experiment be replicated elsewhere in the Gulf? Could Dubai be a prototype for other Gulf States in a post-oil era?

While Dubai’s recent impressive performance might seem quite exceptional, it was actually predestined to achieve such results.  History, location, culture and neighborhood have prepared Dubai to become a remarkable achiever. A port at the cross-road   between Arabia, Iran and India, Dubai was well located to be a center of trade as well as a depot for goods for the whole region. For more than two centuries, Dubai was a hub for trade and services to its neighbors, particularly India. Dubai has always been a mercantile town with settled and active Indian and Iranian communities. It has always had the image of a metropolis with multicultural communities; a free and tolerant place to live in. Dubai has always been ruled within a free market framework. Traders are kings in this city and the ruler is the guardian of the merchants’ interests. When oil was discovered in Dubai, it came in almost optimum quantities; enough to boost the economy, but not too much to overwhelm the society turning it into a rentier economy. While oil resources were modest in Dubai, the oil bonanza came in abundance to rest of the neighborhood, this provided Dubai with vast nearby opportunities that it could exploit. Dubai has risen to the task and benefited from the situation.

With little oil at home and affluence of liquidity in the surroundings, Dubai defined its economic strategy accordingly. Consciously or unconsciously, the example of Singapore might have been in the back of the mind. With strict adherence to  market philosophy, the Dubai authorities have created a friendly environment for investments; minimum red-tape, prompt decisions, and an efficient bureaucracy. First class infrastructure was also available; roads, ports, airport, telecommunications, electricity, depots, etc. A free industrial Zone at Jabel Ali was established in the 1970s with a large man-made harbour facility.

It would seem that the target of the development strategy of Dubai is to absorb as much as possible of the liquidity available in the region and beyond, by providing first class services which are not available regionally and by creating, opportunities for profit making. Dubai is, thus providing high quality services for consumption such as hotels, beaches, entertainments, shopping, schooling, media, hospital etc. But Dubai is also creating a vibrant financial market. In both case, the criteria is providing high quality products or what the ruler of Dubai calls excellence. This is a market that caters to the needs of the high income strata. It is true that the needs for unskilled labour are inevitably enormous during the construction phases, but the assumption is that they would eventually be reduced and phased out subsequently. The strategy adopted by Dubai is to concentrate on clean sectors mainly operated by professionals with limited requirements for massive unskilled labour.

In Dubai real estate development is particularly emphasized to the extent that, to a casual visitor, the city gives the impression of a huge workshop with a forest of cranes everywhere. Estimates for the increase in demand for housing seem to justify the present boom in real estate. Should these estimates be realized however, the population mix between nationals and expatriates would be further distorted.  

A booming real estate sector and an exuberant stock market are considered a sign of success and a vote of confidence in Dubai. The participants to these markets are both nationals and foreigners. It is legitimate, however, to raise questions as to the sustainability of the present boom and whether this exuberance might meet the same fate of the American Nasdaq at the beginning of the millennium.

It is worth mentioning here, that Dubai realized early on, that the Gulf’s real comparative advantage resides in the availability of large liquid assets. The Gulf countries are better equipped to undertake investments with high capital requirement thresholds. Dubai thus invested heavily in its airline “Emirates”, which entailed huge upfront capital outlays. It soon became one of the more competitive world carriers. It was born a giant.

It is clear from the above that Dubai has taken advantage from its position in the midst of an environment awash with liquid money and succeeded in identifying a niche to cater for the needs of the super rich. Luxurious consumption, real estate and stock trading proved to be a viable investment at this juncture in time. Can this experience be replicated in other places in the region, Qatar or Bahrain for example?

The strength of Dubai’s experience resides in the fact that it came first in an innovative way. It is an exception. Exceptions cannot necessarily be turned into norm. Late-comers have to invent something different.

Imported Labour:

While the Arab World at large shows signs of demographic pressure, the Gulf countries are characterized by low population density, and in particular by shortage in well-trained and qualified labour.

The population of the GCC countries is relatively small. The total population, including expatriates, was estimated at some 32 million, in 2000. Saudi Arabia has the largest population, 22 million, while Bahrain and Qatar have the smallest. The expatriate population is about one-forth of the total population in Saudi Arabia, but accounts for more than 70 percent of the total in the smaller countries, (Ugo Fusano, Rishi Goyal, Emerging Strains in GCC Labour Markets, IMF, April 2004).

In spite of the high growth in the national population during the past decades, the share of expatriate workers in the labour force continued to increase. The number of foreign workers increased almost fivefold from 1.1 million in 1970, to 5.2 million in 2000. (The Arab Human Development Report, 2002). Less than a decade later, it was estimated that these numbers have risen to more than 5.5 million. Expatriate workers currently account for between 50 percent of employed labour in Saudi Arabia and close to 90 percent in the UAE.

We can distinguish between different categories of job opportunities in the Gulf; government employees, private sector labour, professionals, skilled and unskilled labour. In most GCC countries, more than 60 percent of the national labour force is employed in the public sector. However, in Saudi Arabia and Bahrain the percentage of national employees in the government is higher. National women who entered the labour market over the past decade, are also mainly employed in the public sector. For nationals, there is the implicit guarantee of employment in the government and public sector. Jobs in these sectors are the preferred domain of work for nationals. These jobs usually provide relatively higher wages, job security, social allowances and generous end-of-service benefits. Moreover, promotion in these jobs is mainly based on seniority rather than performance. In contrast, expatriates work mostly for the non-oil private sector and account, on average, for more than 85 percent of total employed workers in that sector (Fasano and Goyal,). Paradoxically, both professional jobs and unskilled workers are overwhelmingly occupied by expatriates. In these cases, the market is usually more competitive.

The difference between national and expatiate labour is not confined to different cultural and sociological background, it is also manifested in unequal economic rights and privileges. This could be a source of latent discontent in the long-run. Second and third generations of expatriates would, normally, be more demanding for equal treatment.

It is clear from the above, that the GCC countries exhibit an abnormally skewed population and labour force distribution, relying too heavily on imported labour. Such a situation can hardly be sustained in the long-run, i.e., in a post-oil era. This situation resulted from two exogenous factors, both of which should be viewed as temporary. The first factor was the discovery of oil in the mid century, the second being the pervasive poverty in the adjacent countries. With oil wealth pull and the poverty push in the neighborhood, the GCC countries found at their disposal huge numbers of trained, skilled and unskilled labour looking for better opportunities. Unfortunately for the Gulf, oil is not a permanent source of wealth; neither is poverty an eternal fate for neighbor countries.

It is fully understandable to expect that the Gulf countries should have relied heavily on imported labour in the early phases of their development. However, following this initial phase of nation-building, the gulf countries should prepare themselves to return to normality. The depletion of oil wealth and/ or the future prosperity of the adjacent countries would render reliance on expatriate labour more and more difficult and expensive. Many international institutions are, already, voicing objections as to the unequal treatment of foreign labour. In the long-run, foreign labour would become rare and more expensive.

The Gulf countries have to prepare themselves for such a new situation. This would entail bold and eventually painful decisions. A more liberal policy towards naturalization of foreign labour, a less protective and paternalistic policy towards the nationals, and, a more egalitarian treatment in work conditions without regard to nationality might be necessary. These are not easy decisions. They amount to a renouncement of the rentier mentality. Very difficult decisions have to be made after so many years of easy going enjoyment of the gifts of nature.

Could regional integration help provide partial solution to Gulf challenges?

Regional Integration:

With the exception of Saudi Arabia and possibly Oman, the Gulf countries are small economies. Economic size is usually measured by GDP. This, however, is not always a fully adequate measure of the economic size. Population is, in many instances, equally important.

Sparsely populated with no other resource except oil and gas, the Gulf countries depend heavily on the outside world. It is no wonder, then, that the Gulf countries are highly globalized, exporting most of their unique resource (oil) and importing almost every other living requirement including labour. Such deep integration in the world economy is, in fact, a matter of necessity rather than of choice. It is the inevitable consequence of small size.

Integration in the world economy has brought the Gulf countries enormous benefits, promoting them from tribal, pre-industrial status into modern consumer societies within a few decades. In the last four or five decades, the Gulf countries have built an impressive network of infrastructure and provided their citizens with generous welfare services. The life style, and amenities available to citizens in the Gulf during such a short period, had taken Western Europe more than two centuries to attain. In the Gulf, this has been made possible only thanks to the region’s integration in the world economy.

However, this success story is not without a price to pay, particularly in the future within a post-oil era. The GCC countries have become oil-addicted acquiescing to their rentier status. Industrialization, outside oil processing, remains shallow because of the narrowness of the local markets and the shortage of national labour. The long-run political risk of total dependence on the outside world can hardly be over-emphasized. The GCC countries are short in labour and long in finance. They import foreign labour and export their surplus capital abroad. In both cases, political risks are high in a post-oil era. The recent political debate, in many Western quarters, over the acceptance of Sovereign Wealth Funds could be portent of bad news in the future. Heavy reliance on imported labour in the midst of privileged national minorities, is no less risky in the long-run.

What then?

Renouncing globalization is not only wrong but also practically impossible. The risks of extreme globalization could, however, be mitigated by strong regional integration. It has to be emphasized here, that historical experience has proven that rather than being a stumbling-block, regionalization is, in fact, a building-block to globalization. Europe is the most obvious example of the convergence between regionalization and globalization. A strong regional cooperation would provide the Gulf countries with a sizeable domestic market thus favoring the establishment of viable industrial environment. Experience has shown that industrialization, even export-oriented, needs a large home-based market. With the exception of Saudi Arabia, Gulf industrialization outside the non-oil sector has very limited scope for further development. Shortage of labour could also be partially overcome within a Gulf integrated economy, particularly if Yemen is included in an enlarged GCC.

Aware of the benefits of regional integration, particularly for security reasons, the Gulf countries agreed in May 1981 to establish the Gulf Council for Cooperation (GCC) among Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. This regional arrangement extends over a reasonably wide economic space with a population of some 35 millions and a combined GDP of some $800 billion.

While the GCC countries emphasized coordination in security matters in the initial phase, economic issues gained increasing importance in later years. Thus, barriers to free movement of goods and services, as well as, to the mobility of national labour and capital have been largely removed. Prudential regulations and supervision of the banking sector are being gradually harmonized, and stock markets are largely open to all nationals of the GCC. A single common external tariff is now in place establishing a quasi Gulf customs union. More ambitious is the commitment to adopt a single Gulf currency by 2012. However, this last initiative has faced a partial setback with the announcement of Kuwait depegging its currency with the dollar, and the subsequent withdrawal of Oman from the negotiation for a unified Gulf currency. The present decline of the dollar and the de facto depreciation of the Gulf currencies, brought to the fore differences among policy makers in the Gulf countries as to the pegging of their currencies with the dollar. The Saudi Arabia seems committed to the maintenance of the link, the Qatari appears to be  less committed to the tie, and the Emirates position is somewhere in between. Another thorny issue is the position of the members of the GCC regarding the candidature of Yemen to join the GCC. The Kuwaiti foreign minister announced recently that his country is opposed to the enlargement of the GCC at this moment.

While it is true that the GCC arrangement is a reasonably a homogeneous block, differences among its members cannot be ignored. Per capita income ranges from less than $ 10,000 in Oman, to over $ 30,000 in Qatar and the UAE. Manufacturing industry is far more developed in Saudi Arabia, and, the financial sector is more diversified in Bahrain. Yemen, a candidate for the GCC, has very little oil resources, yet it has a large population and a promising agricultural potential. Above all, and, notwithstanding these differences, the region shares a common culture and historical background.

In the long-run, the diversity in the GCC, including Yemen, should be a source of strength giving the region more economic vitality and viability. The major shortages of labour in the GCC countries can, to some extent, be rectified by the large population base available in Yemen, provided it is given the proper training and education. Additionally, such a vast and integrated economic space would be helpful to create opportunities for viable industrial investments in the region.

Economic integration among the GCC countries is proceeding reasonably well, though the negotiations for currency unification have lost their initial momentum, and there seems less agreement on Yemen’s candidacy for the GCC membership. Opposition to the enlargement of the GCC is fully understandable in a short-run perspective. It would mean support and eventually subsidizing the poorer Yemen for sometime. The situation is totally different in the long-run. A similar situation faced the Germans before the unification of their country at the end of the century. In the final analysis this is a political choice between the short and the long-run considerations.

Along the same lines, a similar case can be made as to economically integrating the Gulf into the wider Arab world. There is a strong case for complementarities between the finance-rich Gulf and the population-dense Arab countries. However, the political landscape in most of Arab countries is far from conducive to realizing such a grand scheme. The drama of the situation is that the Gulf countries are too small to assume political leadership in the Arab world. They have the financial muscles, it is true, yet they lack the political clout to transform the rest of the Arab world. Having said so, it is also to be noticed that investments from the Gulf to the rest of Arab world have increased substantially over the last few years. The rest of the Arab world has to change economically and even more so politically to attract the Gulf finance. A dream worth entertaining.

Conclusion:

Keynes once said that “in the long-run we are all dead”. He wanted to emphasize the importance of immediate problems, long-term issues can wait. This was, eventually, adequate for the Europeans in the thirties of the last century. To the contrary, such advice would be suicidal for the Gulf countries, it is a luxury they cannot afford. Oil is their lifeblood, yet it is also ephemeral and non-renewable. Fortunately, the Gulf countries are taking the long run after-oil era seriously.

Oil, as has been mentioned, is wealth not income. It is true that the Gulf countries have not formally adopted such an approach to their national accounts. Yet, they are building financial wealth to replace the oil wealth. They are also increasingly adjusting their current expenditures in such a way that they do not exceed the income generated from their financial investments. More and more, oil proceeds are spent on capital formation, mainly financial portfolio, rather than on consumption.

However, financial wealth alone, without a strong home-based economy, is not risk-free. Financially rich but weak countries are an invitation to covetousness. The present debate over the sovereign wealth funds is only a prelude to the kind of risks that could arise against financial wealth not backed by economic or military power. For the time being, these risks are minimal, continuous flows of oil to the world economy as an on-going concern, give the Gulf countries a counter-vailing power against any foreign challenge. In a post-oil era, the Gulf would loose such a defense mechanism, and would be only left with moral rights. Historical experience has shown that morality alone, valuable as it is, can be very ineffective. Aware of these risks, most Gulf countries recognize the need to diversify their local economies by building a strong and viable home-based industry. Industrialization of the Gulf is, thus, part of the diversification strategy.

Industrialization in the Gulf, as it stands now, is either too oil-dependent or too shallow. Limited population size and labour shortage are serious obstacles to establish a viable and competitive industry. Regional economic integration offers the Gulf countries a way out towards a wider market. Though primarily conceived as a security bulwark, the establishment of the GCC proved later to be a wise economic arrangement to overcome size limitation. In this regard, the enlargement of the GCC to include Yemen represents a strategic advantage in the long-run. A more solid base for industrialization would result from enlarging the scope of economic integration to extend to the whole Arab world.

The Gulf survival and prosperity in a post-oil era need bold and imaginative vision beyond provincialism and localism. The present affluence of the Gulf could be complacent and deceptive barring a clear view of the far future of a post-oil era. In a post-oil era, the Gulf countries are too small to survive in a globalized world. Regional economic integration is a reasonable price for the future security.

In the fifties and sixties of the last century, the call for Arab nationalism failed because it was triggered by a desire for leadership and domination by the Mashrek. Could this call be revived in the twenty first century on different grounds? Paradoxically, the Gulf countries need such integration more than any one else in the region. Would the Gulf leadership rise to such a task?

The oil bonanza is a unique opportunity for the Gulf countries as well as for the whole Arab world, to lay the grounds for a strong and viable economy in a post-oil era. The Gulf leaders are now, in the driver’s seat. The situation requires imagination and leadership. Would the Arab’s seize the opportunity? Or, would they miss it, as they often did. Failing to do so, the oil episode would be remembered in the far future, as a midsummer night’s dream, blurring fantasy and reality. History will tell.

Washington, Georgetwon University

 27 March, 2008