Economic Development in Saudi Arabia

Ahmed Al Rajhi, Abdullah Al Salamah, Monica Malik, Rodney Wilson

• Publisher: Routledge
• Year: 2012
• ISBN:
  9781136132827
• Edition: 1
• Topic: Economics
• Subtopic: International Economics
• Index: Economics

The changing political situation in the Middle East poses challenges for the economies of the region, and some see none more vulnerable to collapse than Saudi Arabia's. Yet as this study demonstrates, the fundamentals of the Kingdom's economy are relatively robust, as over three quarters of GDP is accounted for by the non-oil sector, and impressive modern industries have been established, notably in petrochemicals. The financial system functions well, and despite substantial government debts, there is low inflation and currency stability. The private sector increasingly drives the economy, although job creation has been insufficient to prevent rising youth unemployment. The development challenges Saudi Arabia faces are similar to those of other middle-income countries, and three decades of diversification have made the economy less unique than it was in the oil boom years of the 1970s.

1  Introduction

Much of the coverage of Saudi Arabia’s economy in the Western media - and even more in scholarly studies - takes a very gloomy view. In terms of conventional measures such as per capita GDP, the country’s economic development might appear to be going backwards. Per capita GDP amounted to 8,480 dollars in 2001 according to World Bank estimates, less than half the 1970s level. The kingdom’s increasing population is portrayed as a troublesome burden and the economy viewed as on the brink of collapse, with future revenue from oil being problematic. Critics of government policy stress the continuing reliance on expatriate labour, as local manpower still seems unable to run the economy.

Development optimism

Yet the Saudi economy has not collapsed as the critics’ dire warnings have been predicting for over two decades. Indeed, that economy seems remarkably resilient and government economic policy-making relatively robust.

In this study, a far more optimistic view is taken of Saudi Arabia’s economic development while acknowledging its unevenness and paradoxes. Declining per capita income simply reflects generally lower oil prices and stagnant production allied to a rapidly rising population. The increasing indigenous population should be regarded as an asset not a liability, as ultimately the kingdom’s future depends on its young people. A record proportion of the population, both male and female, are increasingly educated, with almost universal primary education and most proceeding to secondary education. Moreover, there are over 374,000 university students, the second largest number in the Arab world after Egypt, a much more populous country. Saudi Arabia has below-average illiteracy for the Arab world, with only 23 per cent of its population over fifteen unable to read and write, these being confined mostly to the older age groups. To its credit the government has given priority to education spending, even during the 1990s when substantial budget deficits emerged. It was defence spending that was cut, not education.

Although per capita GDP has declined, total GDP has continued to grow and by 2001 exceeded 186.5 billion dollars. Saudi Arabia’s is by far the largest economy in the Middle East, being almost twice the size of that of Israel or Egypt, and in the Islamic world as a whole even the successful Malaysian economy is smaller. This economic size is not accounted for simply by oil; indeed, the share of oil in the GDP has declined considerably. Rather, manufacturing has expanded: from less than 5 per cent of GDP in 1981 to over 10.2 per cent by 2001, partly reflecting the world-class, export-focused, petrochemical industry that has been established as well as other energy-intensive activities such as steel making and fertilisers. The two largest companies in the Middle East are quoted on the Saudi Arabian stock market, namely Saudi Telecom and the Saudi Arabia Basic Industries Corporation (SABIC). In addition, a wide range of successful industries cater for the domestic and wider Gulf Cooperation Council (GCC) market, from food processing to pharmaceutical products and construction supplies. Despite the harsh desert climate, agriculture has also been a success, its share of GDP increasing from a mere 1.1 per cent in 1981 to 5.2 per cent by 2001. In the 1970s it was thought Sudan could become the breadbasket for Saudi Arabia; instead, it is the kingdom which exports grain to Sudan, not vice versa.

Services have grown the most rapidly, however: from only 18.4 per cent of GDP in 1981 to 43.1 per cent by 2001. This admittedly includes a vast array of activities, from taxi drivers and housemaids to sophisticated financial services and information technology. As is shown in Chapter 3, it is the service sector that provides most of the employment for Saudi Arabian citizens. This includes not only government services such as administration and teaching but also private services, such as banking, which largely employ local nationals. There are over three million Saudi Arabian citizens in the workforce of which over three quarters are working in the private sector, belying the view that only the government is willing to employ local nationals.

The challenges of globalisation

Saudi Arabia used to be regarded as an open economy though in many respects a closed society. The challenge for the House of Saud was to modernise the economy, while maintaining traditional values, and safeguarding the power structures of the state. To a considerable extent this balancing act between economic progress and social stability worked, despite the enormous changes oil wealth brought, with rapid urbanisation and the arrival in the kingdom of millions of migrant workers.

By the 1990s the twin-track policy of combining economic modernisation with the perseverance of the social status quo has begun to break down. This partly reflected domestic pressures, notably the rise in youth unemployment as the high birth rates combined with the rapidly declining infant mortality rates of the 1970s and 1980s resulted in a rapid population expansion and large numbers of Saudi Arabian citizens seeking to enter the workforce. It was also a result of high, but largely frustrated expectations, as Western materialism had an increasing impact on the wealthier families, leaving the poorer sections of society marginalised.

Closer integration with the global economy is consequently a divisive issue in Saudi Arabian society, with most of the royal family and the merchant elite favouring economic liberalism but others - perhaps the majority - more doubtful about any possible benefits. These differences can be illustrated by the debate over foreign trade and investment, the former being analysed in Chapter 6 and the latter in Chapter 3, where government economic policy is discussed. Trade liberalisation was given a boost by the agreement to make the GCC a customs union in 2001 which involved the introduction of a common 5 per cent external tariff from January 1, 2003. This meant painful choices for Saudi Arabia, as hitherto some tariffs had been at a 20 per cent level in order to protect domestic producers from competition. It also threatened tax revenue losses, as tariffs were the major non-oil source of income. It was clear, however, that unless Saudi Arabia agreed to the tariff reductions at the Muscat summit in December 2001, the UAE, which had only a 4 per cent tariff, would not have been prepared to sign the customs union agreement.

As a consequence of past protectionist policies the kingdom has become less externally reliant, with exports - mainly oil - falling from 67.6 per cent of GDP in 1981 to 41.9 per cent by 2001. Imports peaked in the early 1980s but subsequently fell with the decline in oil income. During the 1990s imports were largely flat, and the balance of trade remained in surplus, even during 1998, which from the kingdom’s point of view was the worst year for oil prices since the early 1970s.

Similar dilemmas to those over trade policy arise over foreign investment, which has been one of the major impediments to Saudi Arabia’s joining the World Trade Organisation. The kingdom has sought to maintain local control of its oil resources, petrochemical industry and manufacturing and services catering for the domestic market. Although some sectors were opened up with the new investment laws of 2001 - notably downstream petrochemicals - many more remain restricted, especially the banking sector and the part-privatised telecommunications sector. Yet even the limited liberalisation encouraged an inward investment of 4.8 billion dollars in 2001, over half the total for the entire Middle East and North African region, demonstrating the large potential for gains. A great prize would be the 25 billion dollars which, it is estimated, will be needed to develop the kingdom’s gas resources. Yet even here there is controversy, as discussed in Chapter 4 on the subject of oil and gas, with Saudi ARAMCO, the state oil company wanting to develop the gas itself with the reported approval support of the Oil Minister, while others - including Crown Prince Abdullah - favour ExxonMobil and certain Western companies as this could speed up the gas development process, assist economic diversification and cost less, at least in terms of upfront expenditures.

Explaining development

The study starts in Chapter 2 by attempting to discover which development paradigm best explains the country’s economic history. Unlike in most developing countries, feudalistic structures were historically underdeveloped in the territories that now comprise Saudi Arabia, partly reflecting its lack of agriculture and limited Ottoman influence in comparison to the rest of the Middle East. A natural egalitarianism flourished throughout much of the traditional pastoral economy, with little accumulation of capital or wealth. Only in the trading centres of the Hejaz was there a degree of class formation, with merchants as the business elite, but even here, small family-owned establishments dominated. There was not even the class stratification found in the smaller Gulf countries, where dhow owners and pearling captains constituted the upper class while the pearl divers could be described as the working class.

The advent of oil and the accumulation of private fortunes by the more successful merchants and many members of the royal family resulted in the emergence of class divisions, which grew over time. It can be argued that this new upper and middle class owes its success to the state, for without state patronage it would not have achieved its success. Yet the position today is more complex, for although state connections may have helped to secure lucrative government contracts and agency monopolies in the past, there is now greater competition and a higher degree of transparency in Saudi Arabia than in most other Arab countries. Moreover, - and crucially - the great private fortunes accumulated by many Saudi Arabian nationals are often invested abroad and beyond state control. One study by the Saudi American Bank found that in 2001 85,000 Saudi families controlled overseas assets worth over 700 billion dollars. Their future prosperity depends more on the fortunes of the global economy and international financial markets than on local government patronage. The kingdom’s growth may not yet be self-sustaining but that of many of its wealthiest citizens undoubtedly is.

Although oil has been crucial for the past development of the Saudi Arabian economy, it is no longer the main engine of growth. Rather, it is domestic market expansion that drives the economy, a consequence of population increase and a resultant growth in the number of consumers. As in advanced Western economies it is consumer expenditure that keeps the economy moving. It is changes in business and consumer confidence that affect the retail market, not simply oil prices.

Yet it may be premature to ascribe too much of the dynamism in the economy to the private sector, despite the increasing role that has been ascribed to business in recent development plans. This volume draws on survey work from three successful Ph.D. students at the University of Durham with whose studies the author had the privilege to be involved. Monica Malik’s thesis demonstrates the frustration of business leaders in Saudi Arabia with government economic policy. Her interviews with thirty business leaders show that while a great deal has been achieved a considerable amount of work remains to be done, and that there is a lack of confidence that the government’s ambitions for the private sector will be achieved. Indeed, it is alleged that government misunderstands the needs of the business community and must strengthen its capacity for economic management.

Abdullah Al-Salamah, in his study, focuses on workers rather than management, his concern being the adequacy of working conditions in SABIC, the kingdom’s largest manufacturing company with interests in petrochemicals and heavy industrial products. Although SABIC is regarded as one of the country’s best employers, his survey of 312 Saudi Arabian nationals and expatriate employees shows their concern over the usefulness of the training they receive and their dissatisfaction over pay, promotion and the way grievances have been handled by management. In many respects their concerns reflect those of workers everywhere, demonstrating that the attitudes of the Saudi Arabian workforce are not so different to those of workers in the West and in other developing countries. They are willing to articulate their complaints, which helps to put pressure on employers for improvements in the terms and conditions of employment.

Ahmed Al-Rajhi, in his thesis focuses on the electricity industry, which has been extensively restructured with the separation of electricity generation and transmission. This has been carried out in preparation for the eventual privatisation of electricity generation, as in other Gulf countries, with new capacity to be constructed under build-own-operate schemes. The willingness of multinational companies to become involved naturally depends on electricity pricing but, as Ahmed Al-Rajhi shows, this is a complex issue giving rise to conflicts of interest between generators and private and business consumers. If states such as California have difficulty in getting the balance right - as threats of the collapse of its entire system in the late 1990s showed - how much more difficult is the problem in Saudi Arabia as an developing economy. There is also the issue of whether generation capacity should be located closer to the sources of energy (which means Eastern Province) or nearer to consumers in Riyadh or Jeddah. This has implications for regional economic policy.

Overall, an important objective of this book is to demonstrate that, although in the past Saudi Arabia was considered an exceptional economy because of its oil wealth yet limited non-oil economy, today it can be regarded as a more normal one. Its problems are typical of those facing developing countries, particularly deciding what the role of the state should be in economic management. The problems the state has to grapple with - notably budget deficits and rising unemployment - are similar to those found in many other countries. The mainstream development literature has, therefore, a good deal of relevance for the kingdom.

2 Which development paradigm?

The relevance of conventional models of economic development to Saudi Arabia can be debated. In the 1970s and 1980s there was an assumption that the economy was simply resource-based, and rentier in nature, with economic growth or contraction dependent on the price and output of oil.¹ The uniqueness of the economy was stressed, and it was viewed as atypical of developing countries; indeed, many questioned whether the country could even be classified as ‘developing’. This issue still remains a matter of controversy, as in the kingdom’s negotiations to join the World Trade Organisation some of the difficulties have centred on whether the country should be categorised as ‘developing’ or ‘developed’.

A central premise of this study is that Saudi Arabia can be classified as a developing country and that conventional development theory is highly relevant. The economic structures, far from being simple, are complex. Hence the relationships between economic variables and the determinants of economic behaviour can best be understood by applying standard development models. These are required for any meaningful interpretation of economic trends.

Any successful development strategy has to be based on sound theoretical underpinnings. In so far as the kingdom’s development plans encapsulate its development strategy, it is far from clear if this was, or even now, is the case. The first development plan covering the period from 1970 to 1974 was essentially a shopping list. The targets of the Seventh Plan, which covers the period 2000-2005, still remain in many respects an aspiration. They are a wish list rather than an attempt to address the serious underlying economic problems such as unemployment, the lack of competitiveness, the institutional rigidities and the difficulties in fostering an entrepreneurial rather than a dependency culture.

Economic diversification has been on the agenda for five decades, and much has been achieved in petrochemicals and energy-related industries, and to a lesser extent in developing industries to serve the local market.² The employment creation by these industries, most of which are capital-intensive, has been limited, with many of the jobs going to foreign nationals despite the policy of encouraging the employment of Saudis. There is also the issue of the long-term viability of the industries that has been debated ever since their inception,³ and of whether they are capable of developing further or even maintaining their position in an increasingly competitive international environment where treaty obligations and membership of world organisations limits the scope for subsidies. Indeed, the whole issue of Saudi Arabia’s position within the global economy - beyond its being a major supplier of crude oil - has yet to be addressed.

Historical perspectives on market development

Historical approaches that draw parallels with the development experiences of industrialised economies would appear to have some relevance to Saudi Arabia. Most of today’s advanced industrial economies started with structures based on traditional agriculture, with change resulting from internal factors, such as improvements in communications, which enabled markets to operate on a larger scale. Change often came rapidly but was demand-generated by the spread of markets, was often accompanied by population growth which added to the demand for goods and services.

In the case of Saudi Arabia, most attention has focused on oil revenue and in particular on the development possibilities opened up as a result of the 1973-1974 and 1979 oil-price rises. Less attention has been paid to the emergence of a national market made possible by the creation of a modern infrastructure of roads, internal air transport, telecommunications and an electricity grid. Prior to the 1970s, although the kingdom was politically unified, economic transactions between the regions and cities were limited. Jeddah was the major port and commercial centre, but its economic links with Riyadh, the political capital, were restricted. Eastern Province, the centre for oil extraction, was a kind of enclave economy, dominated by Aramco, the Arabian American Oil Company, which employed mainly American expatriates and workers from outside the kingdom.

Arguably the major achievement of the oil era has been the creation of a national economy for goods, services and capital, and to a much lesser extent for labour. The distribution channels for imported goods, and in many cases the servicing arrangements, have become national rather than regional or local. Domestic industries have been established, with subsidised credit from the Saudi Industrial Development Fund,⁴ to serve the national market, with protection through licensing and import tariffs.

The key medium-term issue now facing the non-oil economy is whether the widening of the market to a national scale has reached its natural limits, and whether future growth will simply be in line with gross domestic product growth, which may be modest. In the longer term there is the issue of whether domestic-market reliance can be maintained as the main driving force for the non-oil sector in an increasingly global economy where Saudi Arab...