The Deficit of Oil-Rich Gulf Arab States

The oil-producing countries of the Persian Gulf are experiencing an unprecedented financial windfall. As the price of oil climbed from $25 per barrel on September 11, 2001, to over $135 per barrel in recent months, Saudi Arabia, the United Arab Emirates (UAE), and Kuwait have been among the biggest winners. From the construction of the $6 billion Abraj al-Bait towers in Saudi Arabia to the Mall of the Emirates in Dubai, complete with an indoor ski slope, Gulfies can’t spend their money fast enough.

However, the outlook for this part of the world is not entirely positive. Stock markets are stagnating. Inflation has hammered the region. In some cases, infrastructure is falling apart. Moreover, although the countries of the Gulf Cooperation Council have largely eluded exposure to the U.S. subprime mortgage crisis, it has devalued its $1.8 trillion net foreign assets because 60 percent of them are tied to the plummeting dollar.

Surprisingly, the economies of these countries are relatively free. In other words, fiscal reform does not appear to be the problem. Rather, it is the failure to invest in the education and training of their people that prevents these countries from leveraging their oil wealth windfall into sustainable growth and prosperity.

Saudi Arabia

As of late April, the Saudi stock market (Tadawul, in Arabic) was down 11 percent for 2008, after only a moderate gain in 2007, despite the cash the kingdom generated by selling millions of barrels of oil during its meteoric rise. Indeed, the market crashed in 2006, shedding nearly 50 percent. Since then, failing to gain investor confidence, most Saudi stocks have generated a relatively weak return.

The estimated inflation rate for Saudi Arabia in 2007 was 3 percent to 6.5 percent. This was a 16-year high, but it did not end there. The Saudi Gazette reported in late May that inflation had accelerated to a 27-year high of 10.5 percent.

Arab media reports indicate that Saudi citizens are seething over the escalating prices of essential commodities including rice, milk, fruits, and vegetables. These price hikes have reportedly impacted 40 percent of the population. Yet, the Saudi government refuses to subsidize food staples.

There are other indications that the oil boom has been a bust for everyday Saudis. Reports have surfaced over infrastructure problems. For instance, substandard plumbing systems plague the city of Jeddah, while a shortage in low-income housing reportedly exists throughout the kingdom. Worse still, the cash generated from the sale of oil is not generating jobs. According to the Arabic press, roughly two out of every three Saudi men are unemployed.

United Arab Emirates

If inflation is bad in Saudi Arabia, it has been even worse in the UAE. Indeed, estimated inflation in 2007 was 8 to 11 percent. Food prices reportedly rose 27 percent, and the cost of rent has risen uncontrollably. The ruling emirs have indicated that price ceilings will be implemented on staple goods as a means to prevent further inflation.

Shockingly, the UAE announced that it is planning to import coal to avert blackouts brought on by infrastructure weakness and a development boom.

The UAE is also too dependent upon foreign laborers. The media have identified Dubai, the UAE’s wealthiest emirate, as abusive to its foreign workers, the majority of whom are poor villagers from India, Pakistan, and Sri Lanka. When these workers attempt to leave—due to substandard working conditions, poor housing, and a lack of benefits—employers have reportedly confiscated passports and withheld payments.

Although the stock market index for the Abu Dhabi Securities Market and the Dubai Financial Market has been on a steady rise in recent years, the UAE stock markets may be stagnating. More than three years after its launch of the Dubai International Financial Exchange, initial public offerings (IPOs) of companies that were previously public enterprises have struggled to make gains due to a lack of investor confidence.

Kuwait

The Kuwait Stock Exchange (KSE) has gone higher and higher in recent years. In late April 2008, the KSE had already posted a 5 percent gain. These solid gains, coupled with a massive influx of petrodollars, don’t tell the whole story, however. Estimated inflation for Kuwait in 2007 was anywhere between 2.6 and 6.6 percent, depending upon the source. The rate of inflation is expected to rise again through 2008.

More worrisome for outside investors, however, is the fact that Kuwaiti crude reserve estimates were recently revised down by half, according to one report. This was only one estimate, but it underscores the potential crisis that awaits Kuwait if and when its government-controlled petroleum industry begins to dry out.

A more immediate problem facing the Kuwaiti economy is corruption. According to reports from insiders, no business gets done without favors—financial or otherwise. If they don’t play ball, businessmen are doomed to face an insurmountable bureaucratic malaise.

The British jokingly call the country “Queue Wait” on account of its challenging bureaucracy. This does not only impact individuals seeking to do business in the country. After years of mismanagement, the country desperately needs new utility infrastructure (water, electricity, etc.). The government continues to stumble over itself in providing these necessities to the people.

Finally, the Kuwaiti economy depends upon some 2 million foreign workers to do work that Kuwaitis cannot or will not do. According to the Kuwaiti News Agency, these foreign workers outnumber Kuwaiti citizens by a ratio of 2 to 1. Thus, the future productivity of Kuwait hinges upon the output of an outsized majority of non-citizens who will never be invested in the country’s economic success.

Economic Freedom

Interestingly, Saudi Arabia, the UAE, and Kuwait are not lacking in economic freedom. All three countries rank in the middle of the 162 nations surveyed in the Heritage Foundation’s 2008 Index of Economic Freedom.

Kuwait, which ranked a respectable 39 out of 162, and a few notches above Israel, received very little criticism for its economic policies. “There are no areas in which Kuwait scores poorly,” Heritage reported, “although it is slightly below average in terms of monetary freedom, investment freedom, and financial freedom.”

Saudi Arabia ranked 60th in the Heritage survey, tying the world average in economic freedom. According to the report, the Saudis scored “very well in fiscal freedom, labor freedom, and business freedom.” However, the kingdom is “weak in investment freedom, financial freedom, and freedom from corruption.” Perhaps the most alarming fact about the Saudi economy is that residents are forced to make a 2.5 percent zakat contribution (tithing).

Bringing up the rear was the UAE, which came in at 63 out of 162. The UAE is “weak in business freedom, investment freedom, financial freedom, and property rights,” according to the report. “Foreign investment is restricted, and majority Emirati ownership is mandated even in the free zones.” Finally, the report notes that the UAE’s “financial sector is subject to considerable government interference,” and that its judicial system is “dominated by the UAE’s rulers.”

Thus, while all three countries certainly have been made aware of areas that require improvement in order to reach higher rankings in the index next year, none of these Gulf nations can be accused of stifling free market capitalism in their countries.

Different Deficits

While none of these cash-rich Gulf states are running a financial deficit, all are experiencing shortfalls in other areas. Specifically, they are paying the price for having failed to invest in their human resources. A lack of education and training has left the Gulf plush with petrodollars, but with few indigenous businessmen with the proper training to manage those funds.

According to the Gulf Research Center (GRC), the Gulf states have not yet developed a sophisticated bond market. This has forced many businesses to take on debt in external markets, which translates into lost profits for the state.

The GRC also notes that these countries lack transparency, a reliable system to rate securities, or even a broad spectrum of institutional market participants—the forces that often stabilize prices in other stock markets.

In Saudi Arabia, for example, there is a dearth of analysts to help investors understand the value of publicly traded stocks. “Very few firms are rated,” said Mutlaq al-Morished, chief financial officer of Saudi Basic Industries (SABIC). “People do not read… and we lack research analysts. Only one [Saudi] bank has a real team of financial analysts.”

The Arab News also notes that Saudi Arabia “lacks enough qualified people to work in insurance companies.”

It must also be noted that Saudi Arabia, more than any of the other Gulf states mentioned, excludes half its work force by discouraging women from fully participating in the economy.

The Clock Is Ticking

The West, tired of bleeding petrodollars, is now energized to find the oil-free technology needed to un-tether itself from the Gulf. Further, because countries like Saudi Arabia exclude investment from western financiers, there will be little reason for the West to care about the future of these nations when the need for oil dries up. Thus, the windfall the Gulf is now enjoying will only last so long.

The leaders of these Gulf Arab nations undoubtedly recognize this inevitability. Rather than spending lavishly, they must quickly find ways to turn fleeting oil wealth into long-term investments for their people. Failure to do so will only generate more anger toward the regimes, and perhaps the United States, for which too many of the region’s blunders are blamed.