Saudi policymakers quick to respond to economic change

Saudi Arabia’s third-quarter economic results were mixed.

On the positive side, the fiscal balance improved: the 2017 deficit is expected to shrink to 8.6 per cent of GDP, compared to two consecutive years of more than 15 per cent; while on the negative side, the IMF projected an anaemic growth rate of 0.1 per cent for the economy.

These results have ignited a debate common to residents of western economies: is the government right to pursue austerity policies, or should it look to loosen the purse strings to stimulate the economy? The unconventional structure of Saudi Arabia’s economy means that answering this question requires a novel suite of analytical tools.

Before exploring the unique underpinnings of the Saudi economy, it is worth noting that the headline figures for the Saudi fiscal balance conceal some encouraging details.

In particular, revenues increased 11 per cent yearon-year, and non-oil revenues increased by 80 per cent compared to the third quarter of 2016, driven by new taxes and fees. With the public debt at a mere 13.1 per cent of GDP at the end of last year and foreign exchange reserves covering around two-and-a-half years of imports, the Saudi buffers remain strong.

The key problem – which may or may not be coincidental – is that the kingdom slid into recession during the second quarter of this year, and is flatlining for the year as a whole. This has led many experts and regular citizens alike to argue that the government has hit the fiscal brakes too hard, and that it needs to consider fiscal stimulus to boost private investment. The government’s decision to retrospectively cancel public-sector salary cuts earlier this year suggests that policymakers are sympathetic to this view, as does the reconsideration of the speed of subsidy cuts.

In “standard” economies, the deficit hawks versus doves debate is quite bitter and highly politicised, because it ties into the broader progressive versus conservative controversy over the extent of government involvement in the economy. When economists analyse the issue dispassionately, the debate revolves around the role of the business cycle.

The departure point is the assumption that the economy organically grows at a consistent rate, driven by technological progress. In the short run, events such as a financial crisis push the economy away from this long-run growth rate, but in a mean-reverting manner, that means periods of above-average growth (booms) are followed by compensating slowdowns, while periods of below-average growth (recessions) are followed by compensating accelerations.

The controversy usually revolves around how to tackle recessions. Doves believe that targeted expenditure by the government can speed up the process of putting idle resources to work again, meaning that there is a trade-off between austerity and economic growth.

Hawks regard recessions as part of the economy’s auto-corrective dynamics, and argue that government stimulus disrupts and delays the organic process of resource allocation. Therefore they conclude that austerity is desirable whatever the state of the economy.

In Saudi Arabia, however, the departure point does not apply, because oil dominates the economy. The price of oil – the primary source of income for the kingdom – is what statisticians call a “random walk”, meaning that it does not exhibit mean-reversion: when oil prices rise above their recent average, this does not increase the likelihood of a subsequent fall in the price of oil, and nor are periods of lower prices – such as the post-2014 crash – indicators of an impending rise in the price of oil. This means that when a recession occurs, unlike in a traditional economy, it does not represent a temporary misallocation of resources; it is much closer to a permanent decrease in the standard of living.

As a result, rather than accelerating the return to normality, a fiscal stimulus merely represents a softening of the blow. And if the stimulus is fiscally unsustainable, then sooner or later it will be withdrawn and the economy will fall back to its new, worse state.

In such a situation, analysts should emphasise the primary benefit of austerity, which is that it gives the government credibility in its claim that it will settle its debts. This encourages local and foreign capitalists to invest, as they need not fear the possibility of random expropriation of their assets to settle debts, or defaults which lead to a collapse in the value of their investments.

It is no coincidence that the Saudi government is pursuing austerity at the same time as it is tackling corruption or launching mega- cities – the common thread is attracting foreign capital.

Therefore in Saudi Arabia it does not make sense to delay austerity until “the economy gets back on track”, because it is basically already shifted to the new track. If there is a risk that austerity will generate political instability, then stimulus can be used to buy time. But proponents of a stimulus need to appreciate that the traditional role it plays in advanced economies is absent in oil-dependent ones.

Moreover, the austerity versus stimulus debate is independent of the conservative versus progressive debate; differences in position by well-informed analysts reflect differences in short-run versus long-run considerations, until Vision 2030 (hopefully) succeeds, at which point the Saudi populace can look forward to the traditional ideological food fights.