Efforts by the Gulf Cooperation Council member states (GCC) towards economic diversification have intensified in the wake of the sharp decline in oil prices by 75 per centāfrom US$115 per barrel in June 2014 to around US$27 per barrel in January 2016. Despite financial wealth and relative economic and political stability in most GCC countries, the decline in oil prices has exposed the structural weaknesses of Gulf economies in their heavy dependency on oil and gas and inevitability of bringing about radical changes in the economic system. In the first volume of this work, we acknowledged the political will of these countries to diversify their economies by shifting resources and investments from the energy sector to non-hydrocarbon sectors. We stressed the vital role of the private sector as an engine of growth and effective tool for economic diversification and development. The dynamism, flexibility and creativity of private sector enterprises to take advantage of the available business opportunities allow the private sector to engage actively in all sectors and industries through either outsourcing and contracting from state-owned enterprises (SOEs) , public-private partnerships (PPP) , small- and medium-sized enterprises (SMEs ) or start-ups and micro-companies. Analysis also showed that private enterprises are more flexible and capable of operating outside their national borders by taking advantage of the dynamics of regional integration in order to maximise their profits and market shares.
In this second volume, we explore the key challenges that could face GCC countries in their efforts to diversify their economies. Indeed, the challenges are numerous as diversification is a long-term process and hence requires long-term strategies to bring about noticeable changes in the economic system. The first and foremost challenge is the resource curse and Gulf development model. In fact, the huge increases in oil prices since the early 1970s have led to huge investment in the energy sector and related energy-intensive industries such as petrochemicals , chemicals , fertilisers and aluminium (Auty 1990). More recently, GCC countries have made significant investments in infrastructure , with construction and real estate sectors leading by far all other economic sectors in terms of investment and growth. This limited pace of development raises serious questions about: why have the high expectations for resource-based industrialisation not been fulfilled in the Gulf region? Why have the GCC countries, despite the abundance of capital and cheap energy, failed to develop an industrial infrastructure that could form the base for industrial and technological development, and why have their industries remained uncompetitive in the global markets, except for the petrochemical industry that is still heavily subsidised? The fact that most GCC countries import almost 98 per cent of their needs from international markets also questions the wisdom of the Gulf development model and its consequences for sustainable development in the oil-rich GCC countries. There is no straightforward answer to these questions, but a possible explanation for the failure of GCC countries to develop an industrialisation programme could be their desire to create a service-based economy. Diversification then means the allocation of resources to education , health, financial services , tourism , aviation and real estates . Diversification could also be seen by Gulf countries as long-term strategy, and hence there is no rush to disrupt their economic system as long as oil rents will continue to be the main source of government revenues for the foreseeable future (Luciani 2012).
Rentier State Model and Development in GCC Countries
The rentier state model of development in the Gulf region has its own limitations. The first and foremost challenge is the issues of governance , resources allocation and wealth distribution in the GCC countries. There is a common perception that the abundance of resources often leads to bad governance . This hypothesis is widely tested in countries where governments failed to utilise their national resources to boost their economic, political and social development (Gelb 1988; Auty 1990; Salame 1994; Schlumberger 2007; Ross 2012). Such perception applies to many countries in South America, Africa and Asia, including the Middle East region, where the levels of development are probably among the lowest in the world. Literature attributes much of this connection to the link between resource revenues and authoritarian rule, where political regimes use the resource rents to consolidate their power through either use of government expenditure to buy off opposition or providing better opportunities to deliver services and engage in mainstream policies. This may have been the case in most Middle Eastern countries; and for this challenge to be overcome, these countries should develop their institutional structure and governance mechanisms to interrupt the connection between resource revenues and authoritarianism and between resource rent and increased corruption . Good governance can guarantee the creation of a system, where resource revenues are channelled into the economy for consumption and investment, which will consequently increase economic growth and development.
The rentier state model in the Gulf region is naturally associated with the lack of fiscal policy or absence of taxation because of the abundance of resource revenues and unwritten social contract, where citizens receive rent for loyalty. Luciani (2012) argues that oil has generated huge rent for GCC countries and that the ability of the state to easily capture this rent has enabled these countries to control, spend and distribute their revenues without resorting to impose taxation on their citizens . Nevertheless, current economic conditions indicate that the continuity of this pattern of governing is no longer possible in the wake of declining oil prices and increased budget deficits in all GCC countries in 2015 and 2016. According to Alp Eke, senior economist at the National Bank of Abu Dhabi, GCC economies could incur a net foreign asset deletion of about US$390 billion and a budget deficit of US$300 billion in 2 years (Gulf Base 2016). With the fiscal space of GCC countriesā net oil energy revenues reduced significantly, these countries are expected to have an average budget deficit of 11 per cent of GDP in 2016 and 8 per cent in 2017, with Saudi Arabia, Bahrain and Oman suffering the largest shortfalls in revenues.
Consequently, GCC countries had to borrow around US$318 billion through issuance of local and international bonds to finance their fiscal deficits as a result of lower oil prices between 2015 and 2016, a significant jump from the US$72.1 billion borrowed between 2008 and 2014 (Gulf Base 2016). With oil revenues represent around 80 per cent of government revenues in GCC countries, the impact of prolonged lower oil prices could further worsen the fiscal situation. Investment analysts also expected public foreign assets to decline substantially over the next 5 years. In 2016 and 2017 budgets, most GCC countries have cancelled or postponed a large number of mega infrastructure projects and introduced rigid measures to contain the fiscal shortfalls. Among these new measures are reducing government expenditure by implementing structural reforms, issuing foreign and local debt and improving revenue-generation methods through tax and fee collection. Part of these measures is the decision to introduce 5 per cent value-added tax (VAT) in 2018, which could increase to 10 per cent in the future owning to sustained fiscal deficit for the next 5 years (Gulf Base 2017). The VAT , which exempts foodstuffs and other services such as healthcare and education , will have only a marginal effect on consumers and inflation , but it will be an important step towards diversifying government income and increasing non-oil revenues. Of course, the introduction of VAT is part of a wider fiscal consolidation plan that includes also subsidy cuts and public sector freezes in the GCC countries, but the political implications of this step could be significantly huge in the way these countries are governed in future. According to International Monetary Fund , introducing the VAT in GCC countries will have limited fiscal impact on GDP , as United Arab Emirates (UAE) is likely to raise only 2.1 per cent of GDP from tax , compared to 2 per cent in Kuwait and 1.1 per cent in Qatar. What remains unclear is whether further measures such as income tax will follow this step at a later stage, and how this will affect the nature of the social contract and potential increase of citizensā assertiveness of political rights .
Diversification Outside the Energy Sector
One of the main challenges of economic diversification is to diversify from oil and gas to non-hydrocarbon sectors and industries. The challenges lie in the nature of GCC economies, where oil and oil-related products, and to some extent gas, are the only tradable commodities to be sold internationally for rent revenues. In the GCC countries, where oil rents account for almost 80 per cent of government revenues , this tradable sector receives most government attention, and significant investments are made in this sector, often at the expense of non-tradable sectors that produce for local consumption . Luciani (2012) argues that not only the discovery of oil and gas but also any significant rise in their international prices often results in the demise of traditional productive activities in the GCC countries. This is true, when an increase in oil revenues generates growth in GDP and expenditure , while the cost of production of non-tradable products is higher than importing them from the international market. This so-called Dutch Disease is theoretically ration in international trade theory and empirically notable in the GCC countries, where the discovery of oil and increase in its production and export in large quantities have led to deindustrialisation and disappearance of traditional industries such as pearl fishing. This means that the cost of production in GCC countries would be high that no industry might become internationally competitive. The cases of oil-related industries such as petrochemicals , chemicals , fertilizers , aluminium and steel are clear examples of industries that are exceedingly dependent on state subsidies to survive domestically and compete internationally (Hvidt 2013). For all GCC countries, oil and gas are capital-intensive state-run industries; hence, diversification in the energy sector sustains the leading role of the state in development, a role that is sustained through heavily subsidies to these major oil-based energy-intensive industries that create jobs for the internal market and develop competitive advantage in the ...