The di­ver­si­fi­ca­tion dilemma for GCC sov­er­eigns TREVOR CUL­LI­NAN

Trevor Cul­li­nan dis­cusses the chal­lenges fac­ing Gulf gov­ern­ments as they aim to progress their di­ver­si­fi­ca­tion plans.

Gulf Business - - CONTENTS -

The chal­lenges faced by coun­tries within the Gulf Co­op­er­a­tion Coun­cil in di­ver­si­fy­ing their economies are sub­stan­tial, and many of the trans­for­ma­tion plans al­ready an­nounced look more as­pi­ra­tional than achiev­able.

In the past, the GCC’s large hy­dro­car­bon en­dow­ment – close to 30 per cent of global oil re­serves and 20 per cent of global gas re­serves – and the high in­come this has gen­er­ated, had re­sulted in gen­er­ally com­fort­able net ex­ter­nal as­set po­si­tions, govern­ment fis­cal sur­pluses and low govern­ment fi­nanc­ing needs – un­til oil prices fell sharply in 2014.

A nar­rowly based econ­omy tends to be more vul­ner­a­ble to key sec­tor busi­ness cy­cle swings, am­pli­fy­ing the volatil­ity of its growth, govern­ment rev­enues, and cur­rent ac­count (ex­port) re­ceipts.

To counter this, GCC sov­er­eigns have an­nounced am­bi­tious di­ver­si­fi­ca­tion plans, some of which have ex­isted for sev­eral years. Th­ese plans have re­cently gained new im­pe­tus fol­low­ing the sharp and sus­tained de­cline in oil prices. By and large, gov­ern­ments have pre­sented Na­tional Devel­op­ment Plans (NDPs) or ‘Vi­sions’ with 20 to 25-year time hori­zons, usu­ally in­cor­po­rat­ing five-year in­ter­me­di­ate strate­gies, which help to as­sess whether the coun­try is on track to meet its near-term eco­nomic tar­gets.

Th­ese GCC govern­ment strate­gies broadly tar­get di­ver­si­fi­ca­tion through the ex­pan­sion of sec­tors such as tourism, busi­ness and fi­nan­cial ser­vices along with lo­gis­tics. In our view, it is likely to be a decade long or gen­er­a­tional tran­si­tion. We also be­lieve that struc­tural im­ped­i­ments will ham­per the tran­si­tion to­ward sig­nif­i­cantly more di­ver­si­fied economies.

The bar­ri­ers to di­ver­si­fi­ca­tion are nu­mer­ous.

Firstly, while we be­lieve that US dol­lar ex­change rate pegs re­main ap­pro­pri­ate for their economies, they still hin­der the GCC's abil­ity to com­pete on price in non-oil ex­port mar­kets. As a re­sult, the devel­op­ment of non-oil re­lated ac­tiv­i­ties is damp­ened, ab­sent any off­set­ting ef­fi­ciency or tech­no­log­i­cal ca­pac­ity gains.

Another fac­tor to con­sider is cli­mate. The GCC states are mostly char­ac­terised by a desert cli­mate. On the one hand, the cli­mate is sup­port­ive of tourism dur­ing most months of the year. On the other, the heat se­verely con­strains the devel­op­ment of agri­cul­ture, with wa­ter and arable land scarce. How­ever, devel­op­ment of agri­cul­ture, along with other pri­mary sec­tors, is of­ten the pre­cur­sor of a shift to man­u­fac­tur­ing (sec­ondary sec­tor) and ser­vices (ter­tiary sec­tor).

Given the fall in oil prices and the pres­sure on pub­lic fi­nances, GCC gov­ern- ments are at­tempt­ing to stim­u­late pri­vate sec­tor-led eco­nomic di­ver­si­fi­ca­tion. In our view, this will re­quire skills en­hance­ment of Gulf coun­tries’ work­forces. It is likely that only rel­a­tively high wage pri­vate sec­tor jobs would be suf­fi­ciently at­trac­tive to en­tice na­tional ci­ti­zens away from the pub­lic sec­tor, ab­sent the un­likely event of a sharp fall in pub­lic sec­tor wages. How­ever, in which sec­tors th­ese pri­vate sec­tor jobs are to be cre­ated re­mains un­clear. The lo­cal work­force will likely re­quire sig­nif­i­cant train­ing and ed­u­ca­tion to be el­i­gi­ble for such jobs in any case. In­vest­ment in ed­u­ca­tion will take time to bear fruit.

Open­ness to do­ing busi­ness is prov­ing another di­ver­si­fi­ca­tion con­straint. The im­ple­men­ta­tion of busi­ness-friendly re­forms such as free trade zones, tax in­cen­tives and the eas­ing of tar­iff re­stric­tions has stag­nated out­side of the UAE and is likely to con­strain for­eign cap­i­tal in­flows.

With rel­a­tively small pop­u­la­tions and siz­able hy­dro­car­bon rev­enue gen­er­a­tion, GCC gov­ern­ments have been able to main­tain a cra­dle-to-grave sys­tem of pub­lic sec­tor sup­port for their na­tion­als. This has in­cluded the free pro­vi­sion of en­ergy, ed­u­ca­tion, health and hous­ing, along­side sig­nif­i­cant em­ploy­ment of na­tion­als in the pub­lic sec­tor. Given lo­cal pop­u­la­tions' rel­a­tively high liv­ing stan­dards and work­life bal­ance, the devel­op­ment of a com­pet­i­tive labour-in­ten­sive man­u­fac­tur­ing or ser­vices sec­tor ca­pa­ble of at­tract­ing them away from the pub­lic sec­tor looks to be a sig­nif­i­cant chal­lenge.

Lastly, across the GCC, the devel­op­ment of higher value-added sec­tors, such as busi­ness ser­vices could be one way of en­hanc­ing eco­nomic di­ver­si­fi­ca­tion, given its abil­ity to pro­vide well-paid jobs, tai­lored to suit the rel­a­tively high liv­ing stan­dards of GCC na­tion­als in the re­gion. How­ever, with Dubai al­ready lead­ing the way, de­vel­op­ing a com­pet­i­tive ser­vices sec­tor econ­omy may heighten the risk that GCC economies’ devel­op­ment oc­curs at the ex­pense of each other. This is not to say there can't be chal­lengers, but many of the GCC sov­er­eign’s devel­op­ment plans tar­get the same ar­eas such as tourism, fi­nan­cial ser­vices, and lo­gis­tics. In our view, this could cre­ate sig­nif­i­cant over­laps in the pro­vi­sion of th­ese ser­vices.

There is no doubt that the di­ver­si­fi­ca­tion chal­lenge fac­ing the GCC re­gion is a daunt­ing one. But only through a con­certed ef­fort to em­brace more sus­tain­able rates of growth will GCC sov­er­eigns de­liver their 20 and 30-year vi­sions. If not, then such am­bi­tions will go un­ful­filled.


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