Cmec15 Saif Final

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C arnegiePAPERS

The Oil Boom inthe GCC Countries,20022008:Old Challenges,Changing Dynamics

Ibrahim Saif

Carnegie Middle East Center

N mber 15 n March 2009

Despite the global fnancial

crisis, Gul Cooperation

Council countries have

pursued the same economic

policies. A strong and

consistent commitment to

economic re orm is needed.

Will these states implement

pain ul labor re orm and

diversifcation measures in the

current climate or will they

remain in a holding pattern?


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2009 Carnegie Endowment or International Peace. All rights reserved.

No part o this publication may be reproduced or transmitted in any orm or by any means without permission in writing rom the Carnegie Endowment. Pleasedirect inquiries to:

Carnegie Endowment or International PeacePublications Department1779 Massachusetts Avenue, NW Washington, DC 20036Phone: 202-483-7600Fax: 202-483-1840 www.CarnegieEndowment.org

This publication can be downloaded at no cost at www.CarnegieEndowment.org/pubs. Limited print copies are also available. To request a copy, send an e-mail [email protected].

The Carnegie Middle East Center

The Carnegie Middle East Center is a public policy research center based inBeirut, Lebanon, established by the Carnegie Endowment or International Peacein 2006. The Middle East Center is concerned with the challenges acing politicaland economic development and re orm in the Arab Middle East and aims to betterin orm the process o political change in the region and deepen understanding o the complex issues that a ect it. The Center brings together senior researchers romthe region, as well as collaborating with Carnegie scholars in Washington, Moscow,and Beijing and a wide variety o research centers in the Middle East and Europe,to work on in-depth, policy-relevant, empirical research relating to critical matters

acing the countries and peoples o the region. This distinctive approach providespolicy makers, practitioners, and activists in all countries with analysis and recom-mendations that are deeply in ormed by knowledge and views rom the region,enhancing the prospects or e ectively addressing key challenges.

About the Author

Ibrahim Saif is a resident scholar at the Carnegie Middle East Center. He is aneconomist specializing in the political economy o the Middle East. His research

ocuses on international trade and structural adjustment programs in developingcountries, with emphasis on Jordan and the Middle East. Sai is currently workingon a regional project on competition and the political economy o the EuroMed Association agreement.

Sai serves as a consultant to international organizations such as the World Bank,the International Monetary Fund, and the International Labor Organization. Heis a ellow with the Economic Research Forum and a member o the Global Devel-opment Network. Be ore joining Carnegie, Sai was the director o the Center orStrategic Studies at the University o Jordan.

He obtained his Ph.D. rom the University o Londons School o Oriental and A rican Studies (SOAS) and has taught at both the University o London and YaleUniversity.


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Contents

Summary 1

Economic Developments 20022008 3Persistent Dependence on Oil 4Public Spending and the Social Contracts 6The E ciency o Constrained Monetary Policy 8 A Resilient Cushion o Foreign Reserves 11

Challenges Facing the GCC Countries 13

Varying Policies Toward Unsuccess ul Diversi cation 13The Labor Market Predicament 16The Threshold o Intolerable Infation 18The Challenge o Governance 19

Conclusions and Policy Recommendations 24


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2 | The Oil Boom in the GCC Countries, 20022008: Old Challenges, Changing Dynamics

Introduction

High oil price levels between 2002 and the autumn o 2008 strengthenedkey macroeconomic indicators in the six GCC countries: Bahrain, KuwOman, Qatar, SA, and the UAE. Real gross domestic product (GDP) groreached an average o 8 percent a year over the 20022007 period, with reserves, investments, and budgets showing equally solid per ormance.

As a result, average GDP per capita across the six countries grew abopercent in the 20022007 period. According to International Monetary Fu(IMF) estimates,2 average per capita income measured in purchasing powparity (PPP) increased rom U.S. $12,000 in 2002 to above $20,000 in 2However, average per capita income concealed wide variations among ctries, ranging rom a per capita income o $16,000 in SA, the Gul s moulous state, to $36,000 in Qatar. This level surpasses the Euro Zone, whiabout $33,000.

Several common eatures characterize the GCC economies: high ddency on oil, a dominant public sector with a signi cant scal surplus, a yand rapidly growing national labor orce, and high dependency on expalabor. The GCC countries ace the urgency to address common challendiversi ying their economies; addressing low productivity and labor msetbacks; developing the non-oil private sector; and improving the capacadministrative and public sector institutions. For years, the GCC counthave been debating the need to adopt collective action to ace these comchallenges. In January 2008, the GCC countries launched a common mathat aims at broadening and deepening the scope o economic exchangyond the movement o goods and services to acilitate both capital andmobility. It is yet to be seen what kind o institutional arrangements wdeveloped to e ciently en orce agreements in that direction.

GCC countries ace common challenges but in varying degrees. Thisting di erences among them in terms o natural resources and ecopolicy should not be underestimated. Countries with relatively limitedand gas resources, such as Bahrain and Oman nd it increasingly di csustain past levels o public spending. On the other hand, SA, despite itsoil production, aces a di erent structural problem related to stagnaproduction-per-citizen rates exacerbated by a rapidly increasing popula With an unemployment rate estimated at 15 percent in 2005, SA aces upressures to re orm its current economic and social model. The UAEQatar with unemployment rates o only 3 percent and per-citizen-oil protion almost six times that o SA, can coast along despite suboptimal poMoreover, some countries such as SA and the UAE su er rom intra-cinequality that has orced them to attempt remedial social support and sping programs.


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Ibrahim Saif | 3

During the period o high oil prices, the accumulating wealth posed aninevitable question: could high oil prices provide solutions to all problems?The high oil prices prevailing in the market provided all the GCC economies,at variant rates, with huge trade and current account surpluses. From there,the upper hand in determining the uture o the GCC economies was that o policymakers. The GCC countries were given a real opportunity to achieveremarkable change in their economic structures by utilizing the accumulatedoil revenues be ore the recent plummeting o oil prices.

This paper aims at exploring the di erent inter-country dynamics that out-line the re orm agenda o the GCC countries regardless o oil prices. It is the

rst in a series o papers that will explore the di erent implications arisingrom the various GCC economic policy challenges outlined here. The papers

will also examine the e ect that di erent GCC policy choices will have onother non-oil Arab countries such as Egypt, Syria, Lebanon, and Jordan.

Economic Developments 20022008Soaring oil prices between 2002 and mid-2008 strengthened the dominanceo oil revenues in the GCC economies. The oil share in the economy increased

rom 30.8 percent o GDP in 2002 to 40 percent in 2006. Oil revenues con-stituted 86 percent o total government revenue in 2006 in comparison to the2002 gure o 77.4 percent. Over the same period, the oil contribution to ex-ports also increased rom 61 to 67 percent. These gures suggest that, despitee orts at diversi cation, the GCC countries are increasingly dependent on a

single source to generate revenues, thus making them continuously vulnerableto oil price fuctuations. However, the aggregated averages conceal importantinter-country di erences. While the share o oil revenues to total governmentrevenues has increased in Bahrain, Kuwait, SA, and the UAE, it has decreasedin Oman and Qatar.

able 1: The Role o Oil in GCC Countries Government Revenues, Exports and GDP (20022006)

Bahrain Kuwait Oman Qatar Saudi ArabiaUnited Arab

Emirates GCC

YEAR 2002 2006 2002 2006 2002 2006 2002 2006 2002 2006 2002 2006 2002 2006

Governmentevenues 67.3 77.0 88.4 90.8 73.1 64.8 63.7 55.2 78.0 89.7 71.5 80.5 77.4 85.9

Exports 30.7 54.3 91.5 83.3 71.3 76.2 62.7 66.1 76.0 81.7 31.9 38.8 60.9 67.6

GDP 24.2 26.0 38.4 55.2 29.9 22.7 56.8 57.3 30.0 32.4 21.2 38.2 30.8 40.1

o rces: Cen ral Bank of Bahrain, 2008 repor ; Cen ral Bank of K ai , 2003 & 2006 repor s; Cen ral Bank of Oman, 2003 & 2007 repor s; Cen ral Bank of Qa ar, 2003 &2006 repor s; Sa di Arabia Mone ary Agency, P blic Finance S a is ics, Ann al Governmen Reven es and Expendi res.


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The increased levels o public spending channeled at modernizing the structure has been a signi cant actor in the diversi cation o GCC coutoward the non-oil sector. Moreover, the deregulation o important sectorsas the nancial sector, education, and tourism has attracted a wider speco investors, thus compelling the private sector to strengthen its compecapacity.

It is important to note that these statistics only measure the direct role oin the economy. I the indirect impact o oil revenues on the service and trial sectors is actored in, the contribution o oil to GDP will be much hthus urther underlining the importance o oil in the economy. The indcontribution o oil revenues will be explored by shedding light on the rooil revenues in the development o the non-oil sectors and the implicatiothat or public policy, monetary policy, and scal policy.

Persistent Dependence on OilThe relationship between the oil and non-oil sectors in the GCC economis interactive and dynamic. Driven by oil revenues, the non-oil sector in countries has succeeded to reduce dependence on oil. However, it is stilclear to what extent growth in the non-oil sector is independent o growoil revenues. Given the uncertain nature o uture energy prices, this raisous policy challenges regarding the enabling conditions that must be nurt

or non-oil growth to be less dependent on oil revenues. The dynamics orelationship will be explored urther when we address the challenge o

cation in the ollowing section.

The continuing dependence o GCC countries on oil exports and oil enue during this period is the result o high oil prices, not o a ailure velop the non-oil sector o the economy.3 In act, the annual growth rate o thnon-oil economy (sometimes re erred to as the non-hydrocarbon econover the period 2002-2006 surpassed that o the oil economy as Figurelustrates. The annual growth in the non-oil sector averaged 7.72 percent. growth resulted in an increase o the non-oil sector share to the total shathe economy rom a low level o 4.4 percent in 2002 to 7.8 percent in 20

At country levels, Figure 1 indicates that the growth o Qatar, Kuwaitthe UAE has been associated with a strong growth in the non-oil sector w

the average per capita o oil and gas is much higher than the rest o thecountries. These economies have been keen about adopting economic potoward the diversi cation o their revenue sources. On the other handSaudi government has been trying to encourage non-oil sectors through ous means, but it continues to exhibit a relatively modest growth rate withoil sector surpassing the non-oil by only a slight margin.

Bahrain and Oman refect a rather di erent picture. Their oil sector istered negative growth rates over the observed period, thus suggestingpoorly resourced countries are unable to bene t rom the hike in the p


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Ibrahim Saif |

o oil and natural resources. Both countries su er rom a rapid decline in oilreserves and a small production capacity. Oil experts emphasize the need orthe two countries to invest in enhanced oil recovery methods. The observedgrowth rate in Bahrain and Oman was mainly driven by non-oil sectors suchas nancial services and construction.

The non-oil sector greatly bene ted rom better targeted public spendingand sharp increases in capital spending channeled toward modernizing theindustrial in rastructure and the deregulation o key sectors. A rapid popula-tion growth, especially in SA (4.6 percent) and the UAE (3.1), required highercapital expenditure on housing and utilities. New roads, railways, ports, andairports were constructed in order to accommodate growing volumes o tradeinside and outside the region. Moreover, the non-oil sector bene ted rom thederegulation o the nance, tourism, and education sectors. For example, SA granted ten licenses to oreign banks to open branches in the country a ter2003. Prior to this date, banks were regulated by a 1976 law that requiredbanks operating in the country to have a majority o Saudi shareholdings.Qatar and the UAE both undertook deregulation in the education sector withthe opening o several branches o reputable international universities; a stepthat is expected to pave the way or establishing a niche market in educationat the regional level.

Unlike the 1970s oil boom, the private sector played a more active role inthe 20022008 boom. The non-oil growth in the GCC countries was drivenby a newly emerging private sector. The private sector evolved rom a merely rentier private sector into a sector run by competent entrepreneurs who nd

Figure 1: Gross, Oil and Non-Oil GDP real Growth in GCC countries, annual average 20032007

So rce: Regional Economic O look 2007, In erna ional Mone ary F nd.

-6%

-4%

-2%

0%2%

4%

6%

8%

10%

12%

14%

GCC Bahrain Kuwait Oman Qatar Saudi Arabia UAE

TOTAL

NON-OIL

OIL


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themselves orced to compete more aggressively in order to win contracensure business access. Also, partnerships between the private and publitors became more widespread, which improved the quality o the projectsimplemented in the region. During the 1970s oil boom, the rapid increasrevenue led at times to the implementing o hastily planned and poor quin rastructure and service delivery projects. Recent projects in in rastrand utilities were more care ully selected and according to a predeterm

ramework and were linked to the macroindicators.4 This di erence has rootin the weak institutional capacity o the GCC countries in the 1970s, wresembled that o early-stage developing countries. GCC countries nowin place systems that can cope with the oil wind alls with signi cantly public debt ratios.5

Public Spending and the Social ContractsFiscal policy in the GCC countries has been expansionary and has been utto sustain the social contract between state and society. Public spending hasthe primary tool used to infuence economic per ormance. This has remainecase even a ter oil prices dropped rom an average o $108 in 2008 to a US$75 per barrel in 2009. The scal surplus will drop nearly 28 percent; hever, the GCC countries will nish the ongoing projects without di cultie

Public spending is instrumental to understanding the dynamics o groand oil revenue distribution in the GCC countries. As was previously noterevenues constituted 86 percent o total government revenue in 2006 in parison to the 2002 gure o 77.4 percent. As Figure 2 shows, domestic

Figure 2: Government Spending vs. Tax Revenue (based on 2007 gures) 6

So rce: 2008 Index of Economic Freedom, he Heri age Fo nda ion .

Bahrain

Kuwait

Qatar

Oman

SA

UAE

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

TAX REVENUE (T)

GOVERNMENT SPENDING (G)

GDP-(G+T)


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Ibrahim Saif | 7

constitute a minimal source o government revenue and spending. On average,domestic taxes amounted to less than 5 percent o the GDP, thus constitutinga very low share o the governments revenue. In Kuwait, or example, the taxrevenue makes up around 1 percent o GDP. This means that GCC countriesrely on rent made rom the export o oil in order to generate revenue or nanc-ing public spending.

One can reasonably conclude that public spending rather than taxationpolicy has been utilized as a distributive mechanism in the GCC countries.During the 1970s oil boom, GCC countries launched ambitious programs o public spending on in rastructure and services. With the relative decline in oilprices during the 1980s and 1990s, GCC countries aced increasing problemsthat led to intensi ying budget de cits, thus crippling the governments ability to ace turbulent social problems. Unemployment rates were remarkably high:15 percent in SA and 17.5 percent in Bahrain and Oman. Governments oundthemselves in a vicious spiral driven by the necessity to reduce budget de -citsthus public spendingand the social pressure to provide public services.This unsustainable situation exerted an increasing pressure on governments torethink their economic and social policies.

For better or or worse, the 2002 spike in oil prices allowed GCC coun-tries to avoid going into a domestically challenging area o restructuring.Governments resorted to simply increasing domestic spending on current andcapital expenditures by allocating more resources to health, education, and wages or nationals. Hence, the oil boom delayed some o the economic re ormmeasures that the GCC countries had contemplated prior to 2002: increasing

the level o domestic taxation, opening up some sectors, and implementingpolicies aimed at increasing nationals employment in the private sector.

The relaxed scal policy was refected in a policy o minimal taxation. GCCcountries have a very narrow domestic tax base; yet, given the accumulated

oreign reserves, it is very unlikely that this source o government revenue willbe tapped more signi cantly in the near utureeven with the recent drop inoil prices. According to the Index o Economic Freedom 2008,7 most o theGCC countries enjoy a very high degree o scal reedom measured by taxrevenue to GDP. The rate is highest in Bahrain with 5.5 percent, 5.1 percentin SA, 4.6 percent in Qatar, 2.1 percent in the UAE, and only 2.8 percent in

Omaneven though Oman is not an oil rich country. In Kuwait, this ratio was 1 percent, the lowest in the region.

This minimalist taxation policy is part o the in ormal social contract be-tween the state and society in most GCC countries, where states choose not totax their citizens. In return citizens do not participate e ectively in decision-making but enjoy the bene ts o oil revenues. The absence o real participationhas important implications on transparency and good governance.8 Kuwait, which has regular meaning ul elections and a power ul parliament, is the ex-ception to this rulealthough quality o governance there, too, remains low.


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Despite the rise in energy prices that lasted a relatively longer period (to mid-2008) than the volatile rise and all o oil prices between the 1971980s, most o the GCC countries were nevertheless conservative in expapublic expenditures and accumulating reserves and were keen on payingsome o their internal and external debt. There ore, the 20022008 pspending expansion was associated with a relatively stricter public polreduce public debt. A ter 2002, GCC countries managed to control pudebtreduced it to an average o 20.4 percent o GDP in 2006 comp with an average o 69.9 percent in the 19982002 period. SA registerehighest debt-to-GDP ratio in 2006 with a 28 percent level; they were ollby Bahrain with 23.3 percent; Kuwait had the lowest at 8.5 percent. Tconservative approach stems rom past lessons rom the 1970s oil boomthe GCC countries ound themselves accumulating high levels o externinternal debt relative to their GDP.

Given the accumulated current account surplus, GCC countries could ily a ord to repay their domestic debt. However, they did not do so. Thin order to preserve stock o government securities and bonds that couused at later stages or monetary purposes, like setting a benchmark or rates and absorbing excess liquidity rom the nancial markets.9

Although GCC countries ollowed a more prudent policy with the use orevenue, their scal policy still needed to address a number o key chall1) designing measures to avoid the infationary pressure o public spendinenhancing the e ciency and transparency o public expenditure; and 3) ing steps to diversi y sources o revenue away rom oil. In order to res

these challenges, the GCC countries needed to strengthen their scal admtrative capacities by introducing international best practices concerning bupreparation and expenditures monitoring. These issues did not seem to hprimacy given the relaxed scal position the GCC countries enjoyed duthe period under review.

The E ciency o Constrained Monetary PolicyMonetary policy in the GCC countries has been constrained as a result otight link between the GCC and the U.S. economy through the pegging o currencies to the U.S. dollar. Additionally scal, not monetary, policy has

the primary tool that has been utilized to infuence economic per ormance With the exception o Kuwait, the exchange rates o the GCC co

currencies are pegged to the U.S. dollar. Though this policy prevents cebanks rom utilizing domestic interest rates as a monetary tool to contrfation, it does have merits. Given the importance o oil revenues, the peregime serves to stabilize exports as well as government revenues. Morehas a signi cant role in enhancing the credibility o monetary authoritierestricting currency speculation.


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Ibrahim Saif |

However, during 20022008 there was a widening discrepancy between thebusiness cycle in the GCC countries and the U.S. economycoupled with thesharp decline in the value o the dollar in comparison to the Euro and othermajor currencies. This triggered a debate over the appropriateness o the cur-rent monetary policy. The U.S. economy had begun to slow and show signs o impending recession as early as mid-2007; this led to the easing o monetary policy and the reduction o interest rates. The GCC countries were thus orcedto reduce interest rates as well though their economies were already overheatedand su ering rom infationary pressure. A high rate o infation and a low nominal interest rate resulted in a negative real interest rate, thus spurring rapidcredit growth and adding uel to already rapidly expanding domestic demand. With the even more severe economic slowdown o 2008, it is expected that theGCC countries will register a slowdown in credit growth during the secondhal o 2008 and into 2009. This, combined with the recent strengthening o the dollar and the decline in commodity prices, should dampen infation andmake monetary policy more e cient.

The GCC countries are not expected to alter their current exchange ratepolicy given that, as an IMF report (2008) argues, nominal e ective exchangerates have not shown a high degree o appreciation vis--vis other currencies.This implies that the impact o the exchange rate on infation is limited andthe current trade-o in avor o stability is worth pursuing. This line o argu-ment is even more convincing a ter the global nancial crisis and the strength-ening o the U.S. dollar against other currencies.

Another explanation or this decision is related to political considerations,

i.e., close GCCU.S. relations that make it more di cult to abandon the pegor even to diversi y the asset port olio. While this is understandable, it shouldstill be possible or GCC countries to at least partially diversi y their assets, which will reduce both vulnerability and market volatility.

Table 2 shows that the GCC countries maintained a constant average o 46 percent o GDP o domestic credit extended to the private sector over theperiod 20022007. However, it is important to highlight varying rates amongthe countries. Except or SA and Oman, the rates have been increasing at di -

erent speeds. Credit growth was highest in Kuwait, where credit exceededGDP by 4 percent. It was ollowed by the UAE with a credit-to-GDP ratio

reaching 80 percent. SA witnessed a decline in this ratio rom around 41 per-cent in 2002 to around 18 percent in 2007; this was mainly due to a correctionin the stock market, which shows that a large part o that credit was used orspeculation in the stock market.

Most credit in the GCC countries is in the orm o personal loans, indicat-ing public con dence in the per ormance o the economy and an increaseddemand. This is triggered by higher wages that encourage consumption andenhance the creditworthiness o individuals be ore credit institutions.


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Even though credit ratios have been increasing over the past years, are still considered low i compared to developed countries. In the EUthe United States, or example, credit-to-GDP exceeds 100 percent andpercent respectively. Rapid credit expansion can undermine the qualitbanks port olios i the capacity o these banks to assess the creditwoo borrowers ails to keep pace with the growth o lending;10 these warningsproved accurate in the nancial meltdown o September-October 2008. IGCC, the estimates o capital adequacy (the ratio o capital-to-risk-weassets) ranged rom 16.7 percent in the UAE to 21.9 percent in SA. This stands at a much higher level than that required by the Bank o Internat

Settlement upon which the soundness o the banking sector is assessedover-conservative attitude by banks refects the regions higher economicgeopolitical risks. In the wake o the global economic crisis, GCC bankremained well capitalized and pro table, with a ratio o nonper ormingto total loans o less than 5 percent. And with a ew exceptions, they havited exposure to complex products based on mortgages. Moreover, monauthorities reduced interest rates and introduced measures to provide liquto the banking system. Some o these measures were in contrast with meintroduced earlier: an increase in reserve requirements and guarantees ondeposits. These were adopted to cool down the overheated economy an

absorb some o the excess liquidity in the market.11Deposits in the GCC countries are mostly o a short-term maturity, m

ing it di cult or banks to make long-term loans. During most o the punder study, banks pre erred to extend loans in seemingly secure marketsas real estate where they were guaranteed with strong collateral. This rein an overexposure to the real estate market, and thus correcting this ma was made more di cult since banks port olios were not adequately diveIn response, GCC governments need to acilitate the development o newthat allow banks to engage in issuing corporate bonds and venture cap

Table 2: Domestic Credit / GDP 20022007

2002 2003 2004 200 2006 2007

BAHRAIN 46.10% 44.78% 48.27% 49.93% 48.56% 61.73%

KuwAIt 79.38% 78.59% 74.15% 77.17% 86.05% 104.31%

OMAN 40.30% 38.00% 34.28% 27.98% 28.48% 33.84%

QAtAR 39.78% 38.63% 33.68% 35.28% 36.98% 46.37%

SAuDI ARABIA 40.94% 43.31% 41.71% 30.00% 23.00% 17.90%

uNItED ARAB EMIRAtES 44.87% 46.86% 50.82% 57.98% 66.61% 81.87%

GCC 46.16% 47.67% 46.50% 41.60% 41.17% 46.01%

So rce: In erna ional Financial S a is ics Da abase 2008, In erna ional Mone ary F nd, h p:// .imfs a is ics.org/imf.


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Ibrahim Saif | 11

Also there is a need to create credit bureaus that can more e ectively assessrisk. This must be associated with strong regulatory institutions in order toavoid fuidity or abuse in the bond market. This has become more pertinenta ter the global nancial crisis that has revealed how devastating the weaknesso regulations can be.

In sum, monetary policy in GCC countries su ers by varying degrees rom se-rious limitations in its ability both to infuence business decision makers (banks)and to contain infation. Partially or these reasons, the GCC countries still rely on scal not monetary policy as the main macro tool to control infation.

A Resilient Cushion o Foreign ReservesThe GCC countries in 20022008 handled oil revenues in a more prudent andconservative manner when compared to previous oil booms. The increase in oilprices had a dramatic impact on the external economic position o the GCCcountries. This allowed them to accumulate considerable current account sur-pluses and to become important international exporters o capital and investorsin the rest o the Middle East and the world. At the same time, countries o theGCC became more attractive to oreign investors, thus attracting high levels o

oreign direct investment (FDI).The relative slow increase in imports in comparison with their exports al-

lowed the GCC countries to enjoy a period o current account surplus. Importso goods and services in the GCC countries increased rom $56.7 billion in2002 to $184 billion in 2007. As a share o GDP, imports increased rom 18.15percent in 2002 to a level o 23.27 in 2007.

The act that import growth remained below that o export earnings insome countries could be interpreted in two di erent ways. First, it may refect,as previously indicated, a more conservative response to the increased oil rev-enues than in previous oil boom periods. Second, it might be more structurally related to existing bottlenecks in the supply-side: a shortage o available raw materials especially or the construction sector and a scarcity o cheap skilledlabor, which limits the tendency to import. It is more likely that a combinationo these two actors led to this relative lag in imports.

The recent economic slowdown and decline in oil prices will infuence the ex-ternal position and the current account surplus. However, GCC countries will be

in a position to continue accumulating oreign reserves though at a lower level.

Imports by Region: Heading East

There is a noticeable shi t in the source o GCC imports, with Asia expandingits share at the expense o the United States. GCC imports rom the UnitedStates have declined rom 16 percent o total imports in 1997 to 11 percent in2006. Meanwhile, imports rom Asia have reached 31 percent o the total in2006 compared to 26 percent in 1997. The rise o imports rom Asia refects thegrowing role o China as the worlds center or low-cost manu acturing. GCC


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imports rom China rose rom 4.4 percent o the total in 1997 to 8 perc2006. Imports rom the EU remain in rst place with a share o 32 perce

Clearly, the surplus in the GCC countries was the result o an expansithe export o commodities. Indeed, most o the GCC countries registeredde cits in the services balances as a result o high levels o service impothe exception o Bahrain that had a surplus due to its role as a nanciain the region. GCC countries also ran a de cit in their net current trans which refects high remittances outfows by expatriate workers. It also ref

ormal development assistances extended either to other Arab countriesthe international community: the $500 million pledges by SA to the WoFood Program and a similar amount to und the Energy or the Poortiative.12 Most o the GCC countries have surplus in net actor income abroad, refecting the return on their holdings o oreign assets through,inter alia, the Sovereign Wealth Funds (SWF) and investment abroad.

The nal outcome is that GCC countries enjoyed a com ortable oreiserves surplus. They were in a good position to invest domestically, regioin other Middle East and North A rica (MENA) countries, and internatally. A ter September 11, 2002, there was an increasing tendency to invthe MENA region in response to restrictions imposed on Arab investmeinternational nancial markets. This boosted the economic role o the Gcountries in the MENA over the last ve years through direct investmentboth the GCC governments and the private sector undertook there. Throutheir SWFs, the GCC countries allocated part o their investments to o Arab countries like Egypt, Morocco, Jordan, and Syria. The channels o

vestment covered various sectors rom industry to real estate to in rastrprojects.

Similarly, the private sector in the GCC countries, which is the richesthe Arab Middle East region, entered in partnerships with their counterparother GCC countries as well as in the Maghreb and Mashreq countries. Gprivate businesses underwent a qualitative shi t rom being dependent state to acting as sophisticated entrepreneurs willing to compete and invea more challenging environment. It is estimated that in the 20022006 percapital outfows rom the GCC to the other MENA countries amountedaround $60 billion.13 The bulk o the investment was directed toward Egy

Morocco, and Turkey.The role o the GCC region was not limited to being capital expor

the region witnessed a net FDI infow as oreign investors were increasattracted to the energy and construction sectors. The increased FDI was the result o the greater openness o most GCC countries, which becamereceptive to oreign investment in sectors that were traditionally limitit. In particular, most GCC countries opened the construction sector to eign investment and allowed participation in some in rastructure projecadopting new nance schemes such as the Build-Operate-Trans er (BO14


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Ibrahim Saif | 13

approach in the UAE. Moreover, the GCC countries became attractive to in-ternational energy-intensive industries because the di erential in energy prices was in their avor. Low energy prices in the Gul , coupled with relatively cheap

oreign labor,15 made the cost advantage o operating in GCC countries very compelling. It is very likely that we will be observing the opening o new plantsin the aluminum, petrochemicals, and steel industries in the GCC countries.

Challenges Facing the GCC CountriesDespite nearly six years in which high oil revenues created avorable macro-economic conditions in the GCC countries, they were still not able to tackletheir long-term economic challenges. The oil wind all actually pushed back attempts to address some o the challenges to the back burner, while the global

nancial crisis has reminded policymakers in the GCC that structural chal-

lenges must be addressed at a time when macroeconomic conditions are avor-able and not when the economies are slowing down.

The challenges can be classi ed into two broad categories. The rst are o a structural nature such as the need to diversi y the economy and the labormarket. The second is o a policy nature and is related to issues o infationand governance.

Varying Policies Toward Unsuccess ul Diversi cation As observed earlier, the non-oil economy in the GCC countries grew at a rate

aster than that o the oil economy. However, more e orts are needed to stimu-

late the diversi cation o the production base. First, well-targeted policies shouldbe adopted to accelerate re orm and acilitate the involvement o the private sec-tor in the economy. Second, both the private and public sectors need to rethink their investment decisions within a comprehensive macro ramework.

GCC countries are adopting three main approaches to diversi cation. Therst ocuses on creating a parallel economy to overcome the existing rigid

structure and burdensome regulations. This is the case in SA and Kuwait. Thesecond aims at promoting a competitive position in sectors such as nance,tourism, and education. This is the case in the UAE, Bahrain, and Qatar. Thethird approach, common across all the GCC countries but to varying degrees,

is related to the economic re orm process. The GCC states have all embarkedon an economic re orm process that aims at encouraging private sector involve-ment and stimulating non-oil sectors by removing regulatory and administra-tive barriers.

Creating a Parallel Economy in SA and Kuwait

SA adopted a two-track approach to re orm the economy: xing the old andcreating a new. Kuwait has been trying to speedup the process o privatizationand urther deregulate the economy.


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To x the old, SA cut down import duties, privatized telecommunicatiand proceeded with the liberalization o the aviation industry. The cou joined the WTO in 2005. To create the new, it embarked on a series o tiatives to develop economic cities with regulations that are conducive tprivate sector. These cities, designed to ocus on a speci c economic ac would serve as centers o excellence that attract new investments. Thought to reduce the centralization o power and oster the development oductivity zones.16

More importantly, this initiative would allow the creation o a parallel omy that would sidestep the existing bureaucracy, which hindered private inments in the past.17However, the rising challenge is how to maintain the balaand harmony in this emerging dual system without widening the gap and uexacerbating income and regional disparities in SA; or unlike the smallercountries, intercountry inequality is a serious and critical issue in SA.18

Kuwait, on the other hand, has ocused its e orts on speeding-up thcess o privatization and introducing urther de-regulation to the econ Approval o a ramework or Build-Own-Operate contracts was issuedlate nineties, as well as a decision to signi cantly cut taxes on oreignpanies rom 55 percent to 15 percent. A law was also passed by the pment allowing the privatization o Kuwait Airways. Like other GCC counKuwait has also been involved in large residential and tourism projects oKuwaiti islands o Bubiyan and Falaika, which also includes developingsea port on Bubiyan and an $85 billion plan or Madinat al-Hareer (CitSilk).19 These projects and investments mean that the public sector is injec

money into the economy and also opening opportunities or the private sto play a more active role.

Creating Market Niches

In other GCC countries, there was a more premeditated shi t toward nonsectors, particularly in nance and tourism over the past ve years. DubaQatar launched nancial centers, the Dubai International Financial Cenand the Qatar Financial Center respectively, to compete with Bahrain thranked the rst nancial hub o the region. Bahrain, in turn, gave new imto its own position with the launching o the Bahrain Financial Harbor.

Developments in the tourism sector were even more remarkable. Dubaitured the most attention with the construction o attractive destinations sas the worlds tallest tower and largest shopping mall. Abu Dhabi also laumassive tourism projects, including the development o islands similar todeveloped in earlier years in Dubai. In this direction, the UAE paid $million to use the French Louvres museum name and is expected to paadditional amount o $788 million to the Louvre and other French muse

or management and advice.20 In Qatar, there has been an extensive ocus attracting top universities to open branches in the small country in orde


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Ibrahim Saif | 1

host students rom around the region. The Qatar Foundation set up the SidraMedical and Research Center in Doha with a nearly $8 billion endowment.21

In Oman, the government initiated re orms that aim at opening up theeconomy. In line with this re orm e ort, the government passed a new TaxLaw in September 2003 and a new Privatization Law in July 2004. The gov-ernment also opened key economic sectors such as telecommunications, power,utilities, and tourism or private sector participation.22

Many o the diversi cation e orts were duplicated across the region, thusraising the risk o oversupply. Most countries o er the same services and simi-lar attractions (shopping, tourism, business con erences) and demand mustcome rom abroad i these investments are to achieve high return on the equity invested. This is the case in the nancial sector with our countries competingto become the regional nancial hub. Moreover, tourism would be particularly exposed to any serious escalation o geopolitical tensions, and demand rom within the region would not be enough. The diversi cation e orts su er romserious limitations and an unclear vision, and it remains to be seen how suc-cess ul the policies will be over the longer term.

Outsourcing Economies

In their attempt to diversi y their economies and address domestic supply problems, GCC countries explored opportunities outside their borders. In par-ticular, these countries sought to enhance their ood security by investing inagricultural production abroad. The UAE and SA both invested in the agricul-tural sector in Sudan and Egypt. More recently, SA created a holding company to buy arms and sheries overseas. The Saudi holding company is planningon buying rice arms in Thailand. Qatar and the UAE are considering buy-ing underdeveloped armland, especially in Pakistan and Sudan. The Kuwaitigovernment has been considering Myanmar, Cambodia, and Laos as potentialtargets or its investment.23

These outsourcing initiatives come in response to existing limitations onthe expansion o the agricultural sector domestically. For example, high costso production orced SA to abandon its domestic production o wheat, thoughit had achieved sel -su ciency in this crop. The government has embarked ona plan to phase out production by 2016,24 due to the costly desalinated waterused in irrigating the wheat elds. Other GCC countries are expected to ollow the same steps. While the Saudi decision makes environmental and economicsense, it also represents a drawback on the diversi cation e orts; or it will leadto the shrinking o the agricultural sector and a urther increase o dependenceon oil-related industries and services.

Concentrating Access to Credit

Diversi cation in the GCC countries was also hindered by the nature o its nan-cial markets, which are not set up to channel resources to small and medium


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enterprises (SMEs). Small business su ers rom limited access to creresult o an under-developed nancial in rastructure, such as credit buand local credit rating agencies. This makes assessing risk by local bantremely expensive and di cult, encouraging them to reduce lending.25 Hence,the nancial system channels unds almost exclusively to large goverprojects and to well-established business elites. This leaves SMEs that astrumental in enhancing a culture o entrepreneurship and innovation disadvantageous position.

The case o the nancial sector highlights the need or GCC countradopt a comprehensive ramework to guide the process o economic tramation. Detailed policies are needed to achieve the desired goals proclaimgovernments. Along with that, there should be a nancial model and reaable assumptions based on which an action plan can be developed. The sing point o such a plan is clarity about the structure o the desired ecoand decisiveness on the intended goals and tools needed to achieve the detrans ormation. So ar, a ramework that covers all markets does not exrhetoric alone will not change the acts on ground.26 This suggests that this is-sue will continue to saddle the GCC economies or decades to come i itto the natural course o development in the absence o public policies deto invoke the desired changes by establishing the right set o incentivesset o incentives depends on which way each country would like to g which sectors it desires to promote in order to enhance its competitiveThis includes having the right in rastructure and education policies and c

acilities.

The Labor Market PredicamentThe labor market predicament in the GCC countries is characterized by main eatures. The rst is the high rate o unemployment among the yoproblem exacerbated by the high rate o population growth. The second limited role o the private non-oil sector in generating employment opporties accepted by GCC nationals. The third is the status o oreign labor, win most GCC countries constitutes the majority o the work orce. The is the low emale participation among the GCC nationals.

The GCC region aces a di cult demographic pro le, with one thi

the GCC national population under the age o sixteen. This makes develohuman resources and employment a top priority.27 Population growth regis-tered world records with the UAE reaching up to 7.2 percent annual grow2007; even Bahrain, with the lowest growth percentage o 2 percent in 2exceeds the average rate o 1.2 percent o all developing countries.28 On aver-age, GCC countries national population growth is estimated at 3.1 perannuallyone o the highest in the world.

According to statistics published by the Arab Labor Organization, the per-centage o non-national labor o the total labor orce has registered an averag


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Ibrahim Saif | 17

o 71 percent in 2005. Te UAE registered the highest rate at 82 percent, ol-lowed by Kuwait at 81 percent, Oman at 66 percent, SA at 65 percent, Bahrainat 59 percent, and Qatar at 57 percent.29 Te national labor orce participation

aces an even more challenging situation in the private sector. In 2004, out o the total private sector work orce o 850,000 in Kuwait, the nationals account-ed or only 1.8 percent. In Qatar, Oman, and the UAE, the nationals make uparound 10 percent o the private sector work orce; in Bahrain 27 percent, andin SA just over 30 percent.

The structural weakness o GCC states to generate employment opportunitiesattractive to its nationals brings medium-term risks to political and economicstability. Unemployment among nationals might engender disillusionment withthe government. It would also raise the possibility o resentment toward oreign workers amongst nationals. GCC countries leaders expressed their ears regard-ing guest workers in their last summit in Doha in December 2007.30

The policy o trying to substitute oreign workers by natives has become acommon policy across the GCC countries. More importantly, available cheaplabor might contribute to what is known in labor economics as the race to thebottom. The worsening labor conditions would encourage the private sector toemploy the cheapest labor available worldwide rather than investing in humancapital o the GCC national work orce. In the long run, this will reduce laborproductivity and harm the potential o the young national labor orce that isincapable o competing with cheap labor.

The increasing talk about labor conditions o expatriates in the GCC coun-tries comes at a time when international organizations like Human Rights

Watch (HRW) have given more attention to the status o expatriates. Their World Report 2007 addressed the expatriate working conditions o GCCcountries and described that o the UAE as one characterized by abusesagainst migrant workers including nonpayment o wages, extended workinghours without overtime compensation, unsa e working environments resultingin deaths and injuries, squalid living conditions in labor camps, and withhold-ing o passports and travel documents.31

The nationalization attempts in the private sector have been negatively im-pacted by the act that employment in the private sector is usually unattrac-tive or nationals. It is there ore important that the GCC governments correct

the distortions created by infated public wages and concentrate on makingboth skilled and unskilled private sector jobs more attractive to their citizens.Sweeping steps are required, such as legislating better work conditions or ex-patriates. This will increase the cost or employers by introducing minimum wage levels, which will narrow the cost-gap between employing a national anda non-national. Allowing or some orms o collective action might also behelp ul. This option however is quite di cult to calibrate, given the politicalstructure in the GCC countries and the almost complete absence o ormalcollective action.


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The Threshold o Intolerable InfationInfation is possibly a temporary phenomenon in the GCC countries caumainly by external actors and might not refect a serious structural imbalSince mid-2008 infationary pressure receded, though it still poses serchallenges to governments throughout the GCC. It also had serious negaimpacts on GCC nationals and expatriates alike prior to June 2008.

Over the period 20022008, infation in the GCC countries has mainbeen driven by: 1) a depreciating U.S. dollar; 2) strong domestic demancompanied by a growth in money supply and credit; 3) bottlenecks ineconomy and lack o supply, especially in the non-traded sectors such aestate; 4) rising world ood prices; 5) rising raw material prices, or examsteel and cement; vi) and rising labor costs. The global nancial crisis rein a slowdown in credit and world ood prices declined. This was comb with the strengthening o the U.S. dollar against other currencies, espethe Euro. As a result, in late 2008 there appeared to be little reason or Gpolicymakers to worry about infation. However, policy makers need tomore proactive; the same conditions mentioned above could resur ace anto the same consequences as be ore.32

The infation rates in both Qatar and the UAE were particularly high in 20022008 period. First, the two countries had adopted more liberal regtions concerning property ownership or non-nationals, thus driving up pin the real estate sector. What worsened this issue was the concentrated ership o land by the state in these GCC countries which limited the prsectors ability to respond to the increasing demand and meet housing sages.33 Another reason or the registered infation rates by Qatar and the Uis that both countries received a large number o expatriates as their ecogrew at a aster rate compared to other countries.

I infationary pressures recur, containing infation will not be an easy or the monetary authorities. First, monetary policy is constrained giveact that the GCC currencies are pegged to the U.S. dollar, as already

cussed. Indeed, the only policy tool available i boom conditions retu would be limited to the interest rate; but lowering the interest rate at a t when the economy is rapidly growing contradicts the norm (to increaseinterest rate during such times in order to cool the economy). In parallel

GCC countries are generally maintaining expansionary scal policies thauel infation. Associated with infation is the increase in the cost o dom

labor: workers are demanding higher wages to keep up with infation. Tcombination has serious implications or it can easily trap some o the emies in a wage-infation spiral, which would present a serious impedimeeconomic growth.

Alert to these dangers, the GCC countries have resorted to adopting admistrative measures that might help in curbing infation. Several central b


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Ibrahim Saif | 1

have increased the reserve requirements and tightened loan-deposit ratios inorder to slow down private credit growth. All countries are trying to increasethe supply o real estate while at the same time monitoring the market, in orderto avoid dramatic price increases. SA, or example, has introduced new regu-latory measures to control the real estate market in the country. The RiyadhChamber o Commerce launched a real estate pricing scheme that targets vari-ous stakeholders involved in this sector. SA has also introduced new subsidieson some ood items and is keeping the price o gasoline in the domestic marketlow. During Ramadan 2008, the Kingdom allocated 1.15 billion Ryal ($330million) or low-income amilies. Qatar and the UAE have introduced ceilingson rent increases.34

The adopted measures by the GCC countries show that though the authori-ties were well aware o the severity o infation, they believed that they coulddo little to control it. As such, they have been ocusing on trying to mitigateits public impact by increasing public spending, expanding the scope o socialmeasures, and developing well-targeted social schemes.

In response to the nancial crisis, GCC monetary authorities have reducedtheir key interest rates and introduced measures to ease monetary policy. They are doing this by reversing earlier decisions regarding higher reserve require-ments and deposit guarantees in order to encourage more liquidity into themarket. These policies are likely to have little impact on the market and infa-tion because o the defationary mode that dominates the markets today. Asa result o these developments, infation is expected to remain low in the near

uture.

The Challenge o GovernanceIssues o governance continued to hinder economic growth in the GCC coun-tries; and despite advances in some areas, the governments still have a long way to go to remove governance obstacles. Attempting to analyze the governancesituation is critical and su ers rom the inter erence o various misleading g-ures. One should be wary o the economic reedom aggregates that tend toconceal important disparities among the indicators. Hence, this section willaddress governance in the GCC countries by adopting a multi-dimensionalperspective on the issue. The governance structure o the GCC countries will

be examined by looking at sub-indicators separately, in order to provide a morecomplete picture.

The examination o subgovernance indicators calculated by Kau mann,Kraay, and Mastruzzi35 illustrates the weaknesses o GCC countries in terms o governance. This is true o political indicators, which measure accountability, po-litical stability, and absence o violence; economic governance indicators, whichmeasure government e ectiveness and regulatory quality; and institutional gov-ernance indicators, which measure rule o law and control o corruption.36


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Political Governance

GCC countries have di erent systems o political governance, but in political governance in the GCC countries is weak. With the partial ex

tions o Kuwait and Bahrain, the rest o the GCC countries lack eelected bodies that have an impact on decision making. Other countries hollowed various representation ormulas such as the Shura Council in

the consultative bodies in the UAE and Qatar. This is illustrated by Figur which ranks Kuwait on top, ollowed by Qatar, Bahrain, the UAE, OmanSA. However, all the GCC countries score negative values or voice acountability estimates, suggesting that the region needs to rethink its polrepresentation scheme.

Similarly, Freedom House, which measures political rights and civil lties, classi ed Kuwait as partially ree and the other ve GCC count

not ree. Insigni cant tax rates, particularly on personal income, mighvide a air explanation to why citizens have been tolerating poor per orby the government. One can even stretch this argument urther by suggethat the high levels o public spending observed earlier serve as an ininsurance against the rise o public accountability.

Economic Governance

Economic governance in GCC countries scored higher than either politicinstitutional governance. Qatar emerges as the best per ormer ollowed UAE and Oman. Other GCC countries Bahrain and Kuwait scored high ra

with the exception o SA (with a score rate below 50). Based on this recocan argue that the GCC governments have been success ul in implemethe ormulated economic polices.

Figure 4 exhibits the per ormance o GCC countries in terms o ernment e ectiveness over the observed period. This indicator measuquality o public services, the quality o civil service, and the degree o pendence rom political pressures. It also covers the quality o policy tion and implementation and the credibility o the governments commitmto such policies.37

Accordingly, the UAE, Bahrain, Qatar, and Oman score the highest in g

ernment e ectiveness, ollowed by Kuwait. Noticeably, SA lags well This indicator has important implications or the quality o public serprovided by the countries. For example, though spending on education mbe remarkably high in SA, this has not been refected in the quality o grates (potential labor). The Kingdom is not oblivious to this situation and just recently launched various assessment schemes to its provision o services.

E orts o diversi cation will not be success ul i the will is not mented with policy measures to promote private sector development. Regul


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Ibrahim Saif | 21

Figure 3 38: Voice and Accountability or GCC Countries

So rce: S a is ical Appendix ofGovernance Matters VI: Aggregate and Individual Governance Indicators 19962006.

Figure 4: Government E ectiveness


Period (19962006)

E s t

i m a t e s

1996 1998 2000 2002 2003 2004 2005 20060

-0.2

-0.4

-0.6

-0.8

-1.0

-1.2

-1.4

-1.6

-1.8

BAHRAIN

KUWAIT

OMAN

QATAR

SAUDI ARABIA

UAE

E s t i m a t e s

BAHRAIN

KUWAIT

OMAN

QATAR

SAUDI ARABIA

UAE

Period (19962006)

1996 1998 2000 2002 2003 2004 2005 2006

2.5

2.0

1.5

1.0

0.5

0

-0.5

-1.0

-1.5

-2.0

-2.5


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quality, an indicator that measures the ability o the government to ormand implement sound polices and regulations that permit private sector dopment, has been tracked in Figure 5. As the gure shows, regulatory quhas not improved substantially since 2002 and e orts are needed to imthe regulatory ramework or enhancing private sector involvement.

Remarkably, among all indicators, the best scores have been achievgovernment e ectiveness and regulatory quality. However, as the GCC tries have increasingly invested abroad, particularly through the SWFs, comes important to ollow stricter disclosure measures and a greater claSWFs objectives. Furthermore, in order to continue attracting FDI, the Gcountries need to ensure stronger corporate governance standards that impthe perception on corruption.

Institutional Governance

As or controlling corruption, Qatar tops the GCC countries with a score oout o 180 countries surveyed in Transparency Internationals 2007 CorrupPerceptions Index. Qatar is ollowed by the UAE (34), Bahrain (46), O(53), and Kuwait (60); SA (79) ranks at the bottom o the GCC countrThere is virtually no transparency in how these countries prepare their buand allocate their revenues. In the absence o an active parliamentary the potential to mishandle public unds is high and corruption can easilyplace. Enhanced scal discipline can be acilitated by improving the intional ramework in which scal policy operates. That is done via moretive budgetary management and transparency and also by adopting clear regulations.

The GCC countries also need to enhance the legal in rastructure, parlarly the quality o contract en orcement and the independence o courtsserious e orts would enhance the publics con dence in the rules o These important elements o governance have been addressed by the rlaw indicator.

Figure 6 presents the change o rule o law over the 19962006 pRemarkably, Qatar was able to undergo major changes and managed to fipcoin by ranking rst in 2006. However, the act that Qatar ranks rst poquestion on the status o rule o law in the whole region. For despite contional guarantees, Freedom House describes the judiciary as not indepenin practice. Though the Qatari constitution protects individuals rom atrary arrest and detention and bans torture, Law 17, issued in 2002, grantsright to suspend these guarantees or the protection o society.

The GCC countries are aware o the problems ahead o them. Howintroducing the necessary re orms requires a political will. Presently, this weak, and hence the overall governance situation is also weak.39


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Ibrahim Saif | 23

Figure : Regulatory Quality

So rce: S a is ical Appendix ofGovernance Matters VI: Aggregate and Individual Governance Indicators 1996-2006.

Figure 6: Rule o Law


E s t i m a t e s

BAHRAIN

KUWAIT

OMAN

QATAR

SAUDI ARABIA

UAE

2.5

2.0

1.5

1.0

0.5

0

-0.5

-1.0

-1.5

-2.0

-2.5

Period (19962006)

1996 1998 2000 2002 2003 2004 2005 2006

2.5

2.25

2.0

1.75

1.5

1.25

1.0

0.75

0.5

.25

0

Period (19962006)

1996 1998 2000 2002 2003 2004 2005 2006

BAHRAIN

KUWAIT

OMAN

QATAR

SAUDI ARABIA

UAE

E s t i m a t e s


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Conclusions and Policy Recommendations

The GCC countries receive a huge volume o oil revenues; and despitrecent decline in oil prices, abundant revenue infow is expected over the

ew years. The breakeven prices o oil per barrel that balance 2009 budg$36 or the UAE, $38 or Qatar, $48 or Kuwait, $51 or SA, $71 or and $73 or Bahrain. Hence Oman and Bahrain might be at some de citbut other countries should be able to maintain a balanced budget quite ea

Given the accumulated reserves and the solid macroeconomic undatals, the GCC countries are still very likely to achieve strong growth in 2though at a lower rate than those registered over the 20022008 period. top priority in these countries should be enhancing institutional capacitiemanage oil revenues by balancing between creating jobs and improving standards.

Abundant oil revenue provided avorable conditions or growth in the countries. However, the GCC countries have missed the opportunity to aggsively re orm their economies by dealing with the key challenges acindiversi ying the economy, addressing labor market distortion, and increproductivity. The GCC countries also need to revisit their education currito refect labor demand needs, especially in the emerging private sector. calls or engaging the private sector more in higher and technical educatiallowing it to intervene urther in the provision o education services. Abased culture must be encouraged in the appointments o public positionsthe public sector must make it clear that it can no longer act as the employ

rst resort or its nationals. The GCC can introduce a set o incentives courage the employment o nationals: tax breaks or allowances and substraining programs rather than subsidized wages.

Moving to the structure o the economies, diversi cation e orts alenging limitations. Diversi cation in agriculture is already being rediraway rom domestic to international investments. Outsourcing the diverstion e orts in agriculture might prove viable. In other sectors, such as toand nancial services, the diversi cation plans have been exhausted acroregion, thus raising the risk o oversupply. A collective approach in cooring these e orts can help in avoiding duplication and may enhance intion by creating niche markets or each country. Moreover, the GCC counneed to aggressively pursue liberalization e orts to provoke the desired in the structure o the economies. In parallel, there is a need to develop mbased access to small and large credit, the reduction o red tape, and stronindependent courts able to intervene in arbitration.

In terms o scal policy, the problem is that public spending has beemain instrument or promoting growth and redistributing oil revenues;this expansionary scal policy is vulnerable and might not be sustainabthe long run. Non- scal policy instruments should be brought into play


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Ibrahim Saif | 2

encourage growth and achieve redistribution. In addition there is a need orimprovement in managing public spending. This will require a higher degreeo transparency, more accountability, and civic engagement by involving vari-ous stakeholders in budget preparation and inviting independent institutionsto monitor spending.

Monetary policy until mid-2008 proved to be ine cient and highly con-strained as a result o the pegging o the GCC currencies with the U.S. dollar.So ar, the peg to the U.S. dollar regime provides stability. The global nancialcrisis has eased infationary pressure with the credit market slowing down andinternational prices declining. However, the same actors that have led to highinfation still exist; and i the global economy regains momentum, we may wellsee the GCC economies su er again. This suggests that policies to addressthe root causes o infation and weak monetary policy instruments should beintroduced, regardless o the current rate o infation.

While the GCC countries are becoming more open, governance indicatorsare still weak; and developing a ramework to improve the legal and regula-tory environment is needed. These and other e orts present long-term objec-tives that need care ul planning and determination. I GCC economies are toachieve balanced and sustainable growth and to be less immune to the volatil-ity o the energy markets, the leaders o these states must make renewed com-mitments to more undamental governance, scal, monetary, and economicpolicy change.


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Notes

27

1 racking GCC Petrodollars: How and Where Tey are Being Invested Around the World (Washington D.C.: Institute o International Finance, May 31, 2007).

2 International Monetary Fund, Regional Economic Outlook: Middle East and Central Asia, 2007, http://www.im .org/external/pubs/ t/reo/2007/mcd/eng/mreo0507.pd (accessed September 12, 2008).

3 In the economies o the GCC countries, it is important to di erentiate between theoil and non-oil economies. Te oil economies include: export o crude oil, petro-chemical sector, etc. Te non-oil sector is the manu acturing sector (excluding thepetrochemical), construction, and services.

4 Interview with Ali Khalil , Agence France-Presse (AFP), Dubai, November 15, 2008.

5 Kito de Boer and John M. urner, Beyond Oil: Reappraising the Gul States, Webexclusive, January 2007, McKinsey Quarterly, February 2007.

6 Heritage Foundation, 2008 Index of Economic Freedom, http://www.heritage.org/Index/Country.c m (accessed on August 13, 2008).

7 Heritage Foundation, 2008 Index of Economic Freedom, http://www.heritage.org/Index/Country.c m (accessed on August 20, 2008)

8 For more details about the tax system in the Middle East see Patrick A. Imam andDavina F. Jacobs, E ect o Corruption on ax Revenues in the Middle East, IMF

Working Paper (WP/07/270), 2007, http://www.im .org/external/pubs/ t/wp/2007/ wp07270.pd (accessed August 20, 2008).

9 Michael Strum, Jan Strasky, Petra Adol , and Dominik Peschel, Te GCC EconomicStructures, Recent Developments and Role in the Global Economy, EuropeanCentral Bank, Occasional Paper Series, no. 92, July 2008, http://www.ecb.int/pub/pd /scpops/ecbocp92.pd .

10 International Monetary Fund, Regional Economic Outlook: Middle East and Central Asia, 2008, http://www.im .org/external/pubs/ t/reo/2007/mcd/eng/mreo0507.pd (accessed 12 September 2008).

11 Institute o International Finance, Gul Cooperating Council Countries, PressRelease, December 3, 2008, http://www.ii .com/press/press+88.php (accessed onDecember 15, 2008).


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12 BBC News, Arabic, http://news.bbc.co.uk/hi/arabic/business/newsid_7418000/7418184.stm (accessed on January 12, 2009).

13 racking GCC Petrodollars.

14 The Build-Operate-Trans er (BOT) is a type o project nancing, where a privateentity is granted a concession rom the public or private sector to nance, design, struct, and operate a acility or a determined period. Its appeal to governments isa ter the predetermined period ends, ownership is trans erred back to the original

15 Te labor market is currently undergoing important changes and challenges related tothe status o its non-national labor orce.

16 de Boer and urner, Beyond Oil: Reappraising the Gul States.

17 im Niblock and Monica Malik, Te Political Economy of Saudi Arabia(New York:Routledge, 2007).

18 Strum, Strasky, Adol , and Peschel, Te GCC Economic Structures.

19 Kuwait Diversi es to Strengthen Economy, AME In o, April 30, 2008, http://www.amein o.com/155079.html (accessed October 2, 2008). Te project involves thedevelopment o a 250-square-kilometre new city in Subiya that will eature the worldstallest building, the one-kilometer highBurj Mubarak al-Kabir . Other major urbanprojects are also planned to relieve pressure rom Kuwait City, where a $1.8 billionmetro system is also planned or the capital.

20 Robert Booth, From Desert to Cultural Oasis, Complete with Louvre, Guggenheimand Ferrari,Guardian, September 3, 2008, http://www.guardian.co.uk/world/2008/sep/03/middleeast.art (accessed October 2, 2008).

21 Te Qatar Foundation, Sidra and Research Center, http://www.q .org.qa/output/page85.asp (accessed October 10, 2008).

22 Global Investment House,Oman Economic and Strategic Outlook : April 2008 , http:// www.globalinv.net/contentdisp.asp?pageId=329 (accessed July 21, 2008).

23 Gul Countries Agree to Establish Food Company (original in Arabic), Al-Hayat,September 9, 2008, p. 10. Te GCC countries have gone even urther. Te GCCeconomics and trade ministries announced their desire to establish a rm called Gul Company or Food Security, which aims at setting strategies to deal with the ood crises.

24 Saudi Arabia: Buying the Farm,Economist , August 23, 2008. http://www.econo-mist.com/world/mideast-a rica/displaystory.c m?story_id=11975452.

25 de Boer and uner, Beyond Oil, Reappraising the Gul States.

26 Interview with Dr. Hadeel Yasin, Economist at Dubai Council or Development,November 15, 2008.

27 Moin Siddiqi, Gul Cooperation Council Goes or Growth: High-growth GEconomies are Poised or Continued Robust Expansion in 2007 and Beyond Middle East , December 2006, http:// ndarticles.com/p/articles/mi_m2742/is_373/ai_n24996992 (accessed August 3, 2008).

28 United Nations, World Population Prospects Database, http://esa.un.org/unpp/index.asp (accessed September 13, 2008).

29 Arab Labor Organization, 2006 Statistics o Immigration and Labour Mobility in Arab World, http://www.alolabor.org/nArabLabor/index.php?option=com_contentsk=category&sectionid=15&id=85&Itemid=64 (accessed October 3, 2008).

30 Ofcial in the GCC countries pre er the term guest workers or migrant labor, asthe latter may have some implications ofcials pre er not to address.


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31 Human Rights Watch, World Report 2007 , http://www.hrw.org/legacy/wr2k7/wr-2007master.pd (accessed October 5, 2008).

32 Tis is based on IMF, Regional Economic Outlook 2008 and Michael Strum et al. citedearlier.

33 Based on IMF, Regional Economic Outlook 2008 , p 69.

34 In this regard Dubai established Real Estate Regulatory Agency (REEA), which is anadvisory body that aims at enhancing transparency in the real estate market.

35 Daniel Kau mann, Aart Kraay, and Massimo Mastruzzi,Governance Matters VI: Aggregate and Individual Governance Indicators 19962006 (Washington D.C.: Te World Bank, 2007). Te authors argue that the units in which governance is mea-sured ollow a normal distribution with a mean o zero and a standard deviation o one in each period. Tis implies that virtually all scores lie between -2.5 and 2.5, withhigher scores corresponding to better outcomes.

36 Daniel Kau man, Te Governance Gap in the Arab Countries: What Does DataSay? paper presented at IMF/AMF seminar on Institution and Economic Growth inthe Arab Countries, Abu Dhabi, UAE, December 2006.

37 Kau ann, Kraay, and Mastruzzi,Governance Matters .

38 Voice and Accountability (VA) measure the extent to which a countrys citizens areable to participate in selecting their government, as well as reedom o expression,

reedom o association, and a ree media.

39 Yousi Khali a Al-Yousi ,Oil Economies and Globalization: Te Case of GCC Countries ,Proceedings o the Middle East Economic Association, vol. 6, 2004, http://www.luc.edu/orgs/meea/volume6/al-yousi .pd (accessed October 9, 2008).


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About the Carnegie Endowment

The Carnegie Endowment or International Peace is a private, nonpro t organi-

zation dedicated to advancing cooperation among nations and promoting activeinternational engagement by the United States. Founded in 1910, Carnegie isnonpartisan and dedicated to achieving practical results. Through research,publishing, convening, and, on occasion, creating new institutions and inter-national networks, Endowment associates shape resh policy approaches. Theirinterests span geographic regions and the relations among governments, busi-ness, international organizations, and civil society, ocusing on the economic,political, and technological orces driving global change.

Building on the success ul establishment o the Carnegie Moscow Center,the Endowment has added operations in Beijing, Beirut, and Brussels to its

existing o ces in Washington and Moscow, pioneering the idea that a think tank whose mission is to contribute to global security, stability, and prosperity requires a permanent international presence and a multinational outlook at thecore o its operations.


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Carnegie Papers From the Carnegie Middle East Center

200The Oil Boom in the GCC Countries, 20022008: Old Challenges, Changing Dynamics (I. Sai )

European Con ict Management in the Middle East: Toward a More E ective Approach(M. Asseburg)

2008In the Shadow o the Brothers: The Women o the Egyptian Muslim Brotherhood

(O. Abdel-Lati )When Money Talks: Arab Sovereign Wealth Funds in the Gobal Public Policy Discourse

(S. Behrendt)Salafsm and Radical Politics in Postcon ict Algeria(A. Boubekeur)Turkeys Middle East Policies: Between Neo-Ottomanism and Kemalism(. Taspinar)The Middle East: Evolution o a Broken Regional Order (P. Salem)EU and U.S. Free Trade Agreements in the Middle East and North A rica(R. al Khouri)

Algeria Under Boute ika: Civil Stri e and National Reconciliation(R. Tlemani)

2007Lebanons Sunni Islamists A Growing Force (O. Abdel-Lati )The Political Economy o Re orm in Egypt: Understanding the Role o Institutions (S. Alissa)Rethinking Economic Re orm in Jordan: Con ronting Socioeconomic Realities (S. Alissa)Kuwait: Politics in a Participatory Emirate (P. Salem)Women in Islamist Movements: Toward an Islamist Model o Womens Activism

(O. Abdel-Lati and M. Ottaway)The Challenge o Economic Re orm in the Arab World: Toward More Productive Economies

(S. Alissa)

For a complete list o Carnegie Papers, go to www.CarnegieEndowment.org/pubs.

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