Redefining Saudi Arabia’s Dependence on Oil
Sameer Ibrahim
DeVry University

Redefining Saudi Arabia’s Dependence on Oil

Instability in the Middle East and the current decline in oil prices have forced oil-led countries to reevaluate their economic models. Saudi Arabia has seemingly enjoyed long periods of prosperity, but it has come with costs both hidden and obvious. Economic terms such as “resource curse,” and “Dutch disease,” are generally applied to the economic reality Saudi Arabia faces, but a central question emerges: which is the best way forward for one of the United States most consistent Middle East partners to assure Saudi Arabia’s economic viability? Five scholarly journals are examined and policy prescriptions are discussed: Karl (2007) suggests prosecuting corruption; Ross (2001) suggests reforming governmental policies that hinder efficiency; Hamid (2014) suggests promoting gender equity in financial transactions, as well as promoting tourism and agriculture; Gylfason (2001) suggests advancing education reforms; and Hausmann and Rigobon (2002) suggest diversification of Saudi Arabia’s national economy.

Of the Middle Eastern countries that export oil around the world, no country has a more paradoxical relationship with its primary economic resource than Saudi Arabia. Many westerners I have met presume, based on its economic history during the 20th century, that Saudi Arabia is a rich country, of virtually unlimited resources, with very few internal social conflicts or economic restraints. However, this presumption is quickly revised when the historical data of corruption, slow growth, gender bias, a foundering education system, and a lack of diversification are examined. Redefining Saudi Arabia’s Dependence on Oil

Karl (2007) points out that states with the greatest resource reserves, especially oil-exporting countries, have extraordinarily high levels of corruption which has been documented in numerous studies. With weak governmental capacity and an even weaker rule of law in place, there is little institutional restraint. One finance minister stated that, ‘People rob because there is no reason not to.’ This can easily degenerate into what Karl refers to as a “corruption trap,” where payoffs and business institutions encourage the corruption of others until a large percentage of public and private sector figures are involved. In addition, governmental polies are deformed because officials tend to favor larger public sectors with overly excessive regulatory interventions that encourage rent seeking. Also, policy choices are distorted towards financing of mega projects in which payoffs are easily hidden and the collection of bribes is easier while productive long term investment remains undersupplied. Karl also argues that oil appears to impede the appearance of democracy in many cases in the Middle East and actually slows the adoption of governmental reforms and transparency.

Ross (2001) states that the main problem plaguing oil-led states involves governmental corruption. Specifically, oil and mineral dependence has a harmful effect on governments themselves. Oil and mineral states suffer from unusually high rates of corruption, authoritarian governments, government ineffectiveness, and excessive military spending. For example, Ross points out that Saudi Arabia’s spends 35.8 % of its budget on its military.

Redefining Saudi Arabia’s Dependence on Oil

Hamid (2014) addresses fundamental societal issues that relate to Saudi Arabia’s economy, such as the fact that the impact of socio-cultural beliefs and practices (gender discrimination) are blamed for slow growth, while religious practices are credited for boosting the financial sector. The author also discusses the emerging role agriculture and tourism play in present-day Saudi Arabia. Gylfason (2001) discusses the overvaluation of national currency (“Dutch disease”), import protection and corruption, governmental inefficiency, and the general neglect of education and human resources in Saudi Arabia. The author argues that more and better education is needed for rapid economic development. He also sees another factor that tends to influence oil-led countries: “overconfidence resource.”

Hausmann and Rigobon (2002) analyze Saudi Arabia’s chief two-fold economic concern: what to do about an oil industry already suffering from “resource curse,” and what to do about an industry that is mostly responsible for delivering an ongoing decline in GDP purchasing power since the 1980’s. The author’s also generally make the point that the majority of oil-led countries performed remarkably poorly, while the less oil-dependent countries performed better than their counterparts.

Redefining Saudi Arabia’s Dependence on Oil

The context for examining the state of oil-led countries, specifically Saudi Arabia, may be viewed as a function of factors that drive the country’s economic realities. The factors include slow economic growth rates, the cause of “Resource curse (and a related variation,
“Dutch Disease”), corporate and governmental corruption, volatility, the decline of real per capital income, gender issues, and the impact on the poor.

Slow economic growth rates. It surprises many westerners to learn that economic growth rates for oil-producing countries are slower than the growth rates for non-oil producing countries. Further, rarely have oil profits improved the lives of the majority of the people living in oil-producing countries (as cited in Gylfason 2001). The factors that contribute to this relate to an industry characterized by: weak linkages to a broader economy, the most capital intensive industry in the world, a sector which creates few jobs per unit of capital invested, the benefits earned during accelerated economic activity compared to the burdens endured during periods of decelerated economic activity, and the fact that the development model is different than late 19th and early 20th centuries based on the degree of dependence on oil as an export industry (Karl 2007). The question is: how can these results be explained? Gylfason (2001) answers, “Natural-resource based industries as a rule are less high-skill labor intensive and perhaps also less high-quality capital intensive than other industries, and thus confer relative few external benefits on other industries”.

Redefining Saudi Arabia’s Dependence on Oil

“Resource Curse.” According to Karl (2007), “resource curse” is the negative growth and development outcomes associated with minerals and oil-led development. It is characterized by an inverse relationship between high levels of natural resource dependence and growth rates. Karl also refers to this phenomenon as, “the curse of plenty.” Hausmann and Rigobon suggest an alternative definition in which “resource curse” arises from the interaction between specialization and financial market imperfections. In other words, a specialized economy with volatile resource revenue will see a volatile real exchange rate, while a diversified economy will have a constant real exchange rate.

Cause of the Curse. The main driver of “resource curse” isn’t simply the resource itself, but the fact that dependence on a single resource makes diversification of the economy difficult and the result tends to be a permanent loss of competition (Karl 2007). In addition, Saudi Arabia spends 35.8 percent of its annual budget on military spending (Ross 2001), whereas the United States spends 20.07% (including Veterans benefits). Socio-cultural beliefs and practices are also blamed for the slow growth of the financial sector as the conservative culture towards women discourages them from banking and investing (Hamid 2014). Further, the curse is made worse by the failure of public authorities to avert the dangers that accompany the gifts of nature (Gylfason 2001).

“Dutch Disease.” This phenomenon was named after the negative consequences of the North Sea oil boom on industrial production in the Netherlands- the oil booms caused real
Redefining Saudi Arabia’s Dependence on Oil

exchange rates to rise and labor and capital to migrate to the booming sector-the result was higher costs and reduced competitiveness for domestically produced goods and services, which then crowded out other sectors (Karl 2007).

Corruption. Oil exporting countries have unusually high levels of corruption- a reality documented in quantitative evidence in abundant case studies (Karl 2007). Further, oil-led governments seem especially prone to socially damaging rent-seeking behavior on the part of producers, such as governmental temptation to offer tariff protection to domestic produces thus distorting the allocation of resources and reducing both economic efficiency and social equity (Gylfason 2001). States then devolve into sophisticated mechanisms to transfer assets from the primary sector to politically dominant urban groups, as windfall advances provoke a “feeding frenzy” to capture petrodollars (Karl 2007).

Volatility. Both oil and mineral dependent states are exceptionally vulnerable to economic shocks (Ross 2001), and volatility in recent years has grown worse-this has led to even greater economic shocks (Karl 2007). Especially true for oil-led countries, economic shocks are more severe for the poor than for the upper or middle classes, who find it merely necessary to taper discretionary spending, whereas the poor can see their lives imperiled (Ross 2001).

Decline of Saudi Arabia Real Per Capita Income. Although the World Bank found that Saudi Arabia had the largest economy in the Middle East during 2009, purchasing power
Redefining Saudi Arabia’s Dependence on Oil parity for highly resource-intensive countries such as Saudi Arabia…have performed remarkably poorly (Hausmann and Rigobon 2002). Moreover, from 1965-1998, OPEC members experienced an average decrease in their per capita GNP of 1.3 percent per year during this period, compared to lower-and-middle-income developing countries who grew by an average rate of 2.2 percent per year over the same time period (Karl 2007). Further, of the 65 countries that can be classified as natural-resource rich, only four managed to attain both long-term investment exceeding 25 percent of Gross Domestic Product on average from 1970- to 1998 equal to that of various successful industrial countries lacking raw materials and per capita GNP growth exceeding 4 percent per year on average over the same period (Gylfason 2001). Saudi Arabia was not one of them-they were Botswana, Indonesia, Malaysia and Thailand (Karl 2007).

Figer1. GPD per capita at purchasing power parity for different countries

Redefining Saudi Arabia’s Dependence on Oil

The challenges as outlined above, which reflect the paradoxical relationship Saudi Arabia faces relative to its vast oil resources and its relatively slow economic growth, are certainly daunting. The best way forward, according to the above scholars, involves incorporating various public and private reforms targeted at the most easily implemented and most highly prioritized. Education is an obvious component because it can be implemented mostly as a matter of internal national policy. It is also a reform which can be immediately pursued to the betterment of all Saudi Arabian citizens and their families. Agriculture and tourism are two apparent components which have already made impressive gains. Agriculture is also important as a public policy concern with regard to feeding the poorer members of society.

Tourism has been a leading industry based on religious considerations of Mecca and Medina. Gender equity will play an increasingly valuable role since virtually half of the adult Saudi Arabian population is discouraged from participation in the banking and financial sector. However, Hamid argues that this societal evolution might take decades, rather than years. Governmental reforms and transparency will be an important area of concern as China reshapes the world stage, and its appetite for petroleum based products continues to grow. Diversification has already begun in Saudi Arabia as deserts are being converted to farmland, and farming technology continues to reshape the region. Other industries, already mentioned was tourism, also are positive indicators for Saudi Arabia’s redefining itself as less dependent on oil production and diversifying its economy into the 21st century. The above scholars have presented various policy prescriptions. Redefining Saudi Arabia’s Dependence on Oil

Education. Oil dependence is strongly correlated with poor performance in Education (Ross 2001). OPEC countries send 57 percent of their young students to secondary school compared with 64 percent for the world as a whole, and they spend less than 4 percent of their GNP on education - on average - compared with almost 5 percent for the world as a whole
(figures from 1997) (Gylfason 2001). Once per capita income has been accounted for, there is a negative correlation between oil dependence and the key indicators of educational achievement: enrollment in primary school and adult literacy (Ross 2001). Education and human resources have been neglected in oil-led countries (Gylfason 2001).

Agriculture and Tourism. Agriculture and Tourism are playing an ever important role in the development of Saudi Arabia (Hamid 2014). Although Saudi Arabia had not been known as a great agricultural producer, the public sector has begun the process by converting large areas of desert into agricultural areas. With the help of major irrigation projects and embracing large-scale agricultural automation, this has progressed in developing agriculture in Saudi Arabia, adding previously infertile areas to the stock of cultivatable acreage. Further, Saudi Arabia is one the major tourist destinations in the region because it is a destination for a large number of Muslims who come to visit the two holy cities of Mecca and Medina, the two cities define the position of Saudi Arabia among the Arab world (Hamid 2014).

Gender Equity. Men are still the custodians of the family wealth in Saudi Arabia, and thus although the society is slowly embracing equality for both genders, the truth is that it may Redefining Saudi Arabia’s Dependence on Oil

take decades for true equality to be achieved (Hamid 2014). It is widely known that women in Saudi Arabia are not allowed to drive cars. They must also ask their husband’s permission to open banking accounts. This accounts for the perception that the socio-cultural beliefs and practices are blamed for slow growth in the financial sector (Hamid 2014).

Governmental Reforms (Transparency). Oil revenues have not been managed well – more often than not - they have caused crippling economic distortions and been spent on showy projects, weapons and Paris shopping trips for government officials (Gylfason 2001). Ross (2001) suggests multilateral development banks and export credit agencies require firms to disclose complete information about the payments they make to the host governments, including both regular payments and irregular payments. Saudi Arabia could duplicate the Norwegian methodology of dividing oil receipts fairly between present generation and future generations as well as to shield the domestic economy from too much income too quickly (Gylfson 2001).

Diversification. Rentier states are notoriously inefficient because productive activity suffers and self-reinforcing “vicious” development cycles can set in to raise powerful barrier to the diversification away from petroleum dependence, and yield the skewed development configurations described the “resource curse” (Karl 2007). One pathway to diversification involves developing “downstream” industries, which can process and add value to raw materials – these downstream enterprises use large numbers of low wage laborers, and offer opportunities for the poor (Ross 2001). Agriculture has been experiencing impressive growth and the Redefining Saudi Arabia’s Dependence on Oil

government has embraced an open market policy (Hamid 2014). Countries such as Saudi Arabia, become specialized, not because wages in dollars are too high- in fact- if they are able to move to the world of diversification, capital intensity will rise and workers’ wages will increase—moving to a diversified economy is welfare enhancing; it does not imply real wage cuts (Hausmann and Rigobon 2002).

Redefining Saudi Arabia’s Dependence on Oil

References
Gylfason, T. (n.d.). Natural resources, education, and economic development. Retrieved January 28, 2016, from https://notendur.hi.is/gylfason/pdf/eea2000k.pdf
Hamid, S. (2014). Socio-economic Background of Saudi Society and its Impact on the Financial Sector. IJBM International Journal of Business and Management, 9(9), 267-273. Retrieved February 14, 2016, from http://www.theijbm.com/
Hausmann, R., & Rigobón, R. (2002). An alternative interpretation of the 'resource curse': Theory and policy implications. Cambridge, MA: National Bureau of Economic Research.
Karl, T. (2007). Oil-Led Development: Social, Political, and Economic Consequences. Retrieved January 16, 2016, from http://iis-db.stanford.edu/pubs/21537/No_80_Terry_Karl_-_Effects_of_Oil_Development.pdf
Ross, M. (2001, October). Extractive Sectors and the Poor - Oxfam America. Retrieved February 14, 2016, from http://www.oxfamamerica.org/static/media/files/extractive-sectors-and-the-poor.pdf