Iraqi Economists Network

شبكة الاقتصاديين العراقيين

Arab World - MENA Region

Economic Reforms in Major Arab Oil Producing Countries , By A. K. Merza *

For full text of the paper including end-of-paper tables and appendix, click PDF file.

I. The background[1]

Since the commencement of the production of crude oil in the thirties and forties the oil wealth has transformed the oil countries gradually from low- to middle- and some to high-income countries. In the fifties, with the profit sharing agreements the major Arab oil producers enhanced their annual income further and acquired stable flow of revenues. Stability emanated from the then prevailing structure of the oil industry.  It was mainly dominated by a cartel of integrated corporations.  Prices were fixed and continued so, for the next two decades. Economic development proceeded in many countries through development or planning boards, usually advised by the World Bank. Most Arab countries were following the market system. With the wide ranging nationalisation of private ownerships in Egypt in the beginning of the sixties and the following nationalisations in Iraq, Syria and Algeria after independence, the oil countries divided into two groups: liberals and interventionist or Gulf and non-Gulf countries. By the time of the first steep rise of crude oil prices in the beginning of the seventies the political and economic map was generally delineated. The Gulf countries: Saudi Arabia and the rest of the emirates; the others are such countries as Iraq and Algeria. As much as they are different in their economic policies and institutions the similarities are also revealing.

The oil wealth has put immense power at the disposal of the state. This power has been moderated, in the Gulf societies, by the tribal conventions of consensus; thus the private sector continued to function in a relatively open liberal economy.[2]  This was facilitated by the accumulation of foreign assets.  The exchange system, with stable exchange rate, satisfied demand without restrictions. The public sector has grown in these countries[3] but it was, more or less, kept within two bands, public utilities and oil industries. The private sector continued its activity mainly in trade, finance and consumer industries. It also directed part of its activities into financial and freight services that served the whole region. In the second group, the dominance of the public sector is more visible. Endowed with larger populations, and more diversified resources, Iraq and Algeria followed inward looking policies.  The main national symbol was the development of import substitution industries, protected by import quota systems. On the social side employees, in public administration and public sector, have gradually supplanted the old middle class, which was mainly composed of small traders, industrialist, small landowners and professionals, etc. Thus the imposition of restraints on the private sector has been more recurrent.  What separates them from countries in the Gulf pertains to the kind of controls in existence, mainly:

(1) The controls on the exchange system and the evolution of parallel markets in goods and currency. Foreign trade and banking, in the non-Gulf countries were subjected to the control of the state.  The exchange system was restricted and monetary policy subordinated to the budget. In the Gulf, however, the monetary policy was also dormant, but for different reasons, that will have important ramifications when the oil revenues started to decline, for all Gulf countries followed currency-board-type arrangements[4].

(2) The heavy restrictions on the functioning of the market system. The profit criteria usually applied in the market system gradually gave way, in the public sector, to self-contained criteria that increasingly shifts the ground away from cost and benefit considerations. For instance, profit as a main criterion in the inception and continuation of various productive and service activities gave way to such notions as self-sufficiency or meeting demand at any cost, etc.

In both groups, oil revenues were used to harness ongoing policies; the budget therefore has come to be the dominant tool of economic and social policy. Moreover, to guarantee social consent both expanded employment in their civil service.  In current prices the share of the government services in GDP, in Saudi Arabia, grew from about 9% in 1970/71 to 20% in 1999 (table 5). In Algeria it hovered around 12.5% between 1995 and 1999.  In Iraq it stood at about 18% during the period 1984-1990 (ESCWA 1993 & 1997). Employment in the civil service amounted to about 28.4 of total employment in Algeria between 1994 and 1996.

Both groups were also supporting over-valued rates of exchange during the period of sliding oil prices, the Gulf countries through the use of past savings and the rest through restrictions and regulations. The rate of exchange policy was not considered as a tool to compete in the international market.  Consider for instance the behaviour of a non-Arab oil country, Indonesia.  In 1978 Indonesia was not facing impending balance of payments problem. The reserves were adequate, yet it devalued its currency by 34% against the US$ in order to reduce the adverse effects of overvaluation of the rate of exchange on the agricultural exports, (I. M. D. Little, et al, 1993, P.39) [5].

II. The oil connection

In 1983 oil prices started to slide.  The conservation measures on the demand side and coming online of new oil supplies from outside OPEC area (North Sea, China, Egypt, etc) were exerting their effect. After the crash of 1986 [6], oil prices behaved in something like a cycle (see below). The burden of the sliding revenues, during the downturn, borne by the different Arab oil countries was different.  For such countries as Kuwait and UAE the deficit in the current account was a short incident (table 1). As a matter of fact the cumulative current account surplus amounted to US $ 51 billion between 1983 and 1999 in Kuwait. In UAE it was US$ 72 billion (OPEC 1999). That was only possible due to small population and high investment income from abroad. Yet, in Saudi Arabia the deficit had been pervasive throughout this period, the cumulative deficit amounted to US $ 181 billion (tables 4 and 6). The main source of finance was liquidating official foreign assets[7]; see also Box (1). In the non-Gulf countries the storey is somewhat different. The inactive exchange restrictions during the first period were binding in the second.  The current account balance was maintained as much by exchange restrictions as by budgetary measures. Therefore, Algeria realised a limited cumulative deficit of US $ 2.5 billion between 1983 and 1999 (OPEC 1999), compared to a much larger deficit in the first period [8].

II.1 The growth of consumption

Adjustments in oil economies in response to the fall in oil revenues have displayed the disruptive influence of the oil cycle. Despite sterilisation of part of the oil revenues, during 1970-1982, growth of consumption and investment, in real terms, paralleled that of the oil revenues (tables 1 and 2). Non-oil output also experienced high growth, but in its response to the fast rising expenditures it was restrained by more binding (mainly physical and logistical) constraints.  The gap between demand and domestic supply widened.  In the tradables, the gap was increasingly closed by imports. Imports grew, in real terms in all Arab oil countries, at pace with expenditures. Foreign exchange proceeds were more than enough. For instance, in Saudi Arabia total consumption (private and public) rose, in real terms, by 21% annually during this period, non-oil output by 13.4%, and imports by 25.5% (table 3). The rise in economic activity proceeded within a situation of disequilibrium (mainly in non-tradables) and delays in adjustment.

The rise in oil revenues, during the first period in all Arab oil countries, has thus created a level and structure of consumption (standards of living) that has resisted future decline.  This new level of consumption and incomes, which can only be supported by rising oil revenues, has sown the seeds of future course of crises, financial and political. From this stems many policy and restructuring difficulties facing the oil producing countries. This was amply clear in the second period (1983-1999) when declining oil revenues were facing entrenched levels of consumption and stagnating non-oil output. Although growth of spending (consumption and investment) has converged to that of oil revenues, in nominal and in real terms, in most Arab oil countries, during this period, the gap between demand and non-oil output has already widened a great deal[9]. The Gulf countries continued to close the gap through imports, supported either by adequate oil revenues (Kuwait and UAE) or increasingly drawing on foreign assets (Saudi Arabia). The Saudis continued the liberal exchange system at the time when their budgetary measures were not enough to stall the inadequacy of oil revenues. The result was a heavy run down of their (official) foreign assets.[10] In the non-Gulf oil countries, restrictions on imports (and cuttings on subsidies)[11] have increasingly become the main tool to repress demand and thus effectively reducing consumption (standards of living). Public investment was also constrained through budgetary measures and part of private investment crowded-out.  These were the main causes (and effects) to the growth of parallel markets, separation of international and domestic pricing and emergence of present-day crises.

Box 1: Government consumption and official transfers abroad

In 1983 to 1988 national expenditures (consumption plus investment) in Saudi Arabia exceeded the GDP by an average of 10%.  The gap was closed by imports. Current account deficit averaged 4% of GDP during this period. In 1989 to 1999 national expenditures were less than the GDP throughout the period by an average of 6.2%, yet current account persisted in deficit, for eight of the eleven years, by an average of 3.4% (table 4). This was due to the outflow of ‘official transfers’ in the current account,  (tables 4 and 6). These transfers do not include factors’ income. To continue for such a long time in spite of mounting current account deficit an important part of such outflows cannot be unrequited in nature (aids or the like).  Most probably they are defence related. Therefore, they ought to be added to government consumption and at the same time to imports of goods and services in the national accounts (for both periods). In this case the GDP would not change while the share of national expenditures increase, thus giving a more credible explanation for the persistence of the deficit in the second period.

II.2 The growth of non-oil output

During the last 30 years the non-oil output has grown in value to the extent that its share (in GDP) has risen continuously in all oil countries.  The share of non-oil output has risen from 30% in 1975, measured in current prices, to 65% in 1999 in Saudi Arabia, and from 32% to 74% in UAE, during the same period. In Kuwait it rose from 30% in 1975 to 60% in 1995.  The same trend can be discerned in other oil producing countries[12], table (7).  Does this indicate diversification?  It does, if we take the word to refer to the adoption of different modes of professional or social organisation than the prevailing ones.  For instance, the erection of public offices staffed with civil servants enjoying, until 1985 for some and till now for others, fairly comfortable life and gaining similar consumer tastes emulating those in advanced countries.  The development extended to the mushrooming of the service sector, trade and regional financial intermediation with appearances and practices similar to those in the advanced world.  By other criteria, however, this diversification is more apparent than real, especially when it is taken to refer to sustainable development, i.e. the development of alternative activities that insure adequate foreign exchange earnings for fairly long time. First, the dominant foreign exchange earner is still the oil sector (table 8).  Secondly, oil revenues are still the driving force behind both the growth of expenditures (see above) and growth of non-oil output. Let us touch on this latter connection.

With the rise of oil revenues (1970-1982) fast growth has been observed right across the sectors of the economy. The main sources of growth have been:

(1) Investment activities in the infrastructure, social services and manufacturing.  For instance, during these prosperous years value added in construction grew by 18% annually in Saudi Arabia, (table 9).

(2)  The expansion in oil-based industries such as oil products and petrochemicals.

(3)  The expansion in import substitution industries.

The annual rate of growth in non-oil output amounted to 13.4% in Saudi Arabia, 14.7% in Kuwait, 51.1% in UAE and 8.5% in Algeria, during this period, table (10).

In the second period (1983-1999) the fall in oil revenues constrained all these economies. The annual rate of growth in non-oil output amounted to about 1.1% in Saudi Arabia, 2.4% in Kuwait and 5.2% in UAE, during the period, table (10).

Basically, therefore, the growth of the whole economy has been tied to the growth of oil revenues.  The ties are financial rather than organic.  In other words it is the ability to spend (and consequently to import) rather than the inter-industry linkages that generate stimuli to growth. This can be recognised visibly by comparing the growth of real value added in the non-oil sector to the growth of oil revenues.  For the comparison to be meaningful it is necessary to compare growth in the non-oil sector to the growth of real purchasing (importing) power of oil output.[13] It is obvious from table (9), for Saudi Arabia, that the growth of real output of the non-oil sector is closely tied to the growth in the purchasing power of oil output. The association holds for the whole of non-oil output as well as for most of its components. During the first period the real value of oil output grew by an annual rate of 16.1%. Accordingly the non-oil value added grew by 13.4%.  When the value of oil output almost stagnated during the second period (growth of only 1.1% annually), non-oil output followed suit; it grew by 1.1% annually, (table 9).

The interaction between non-oil output and the financial side of oil takes place by proxy, i.e. through the relationship between public expenditures and non-oil output. Our econometric estimation of this relationship, for Saudi Arabia, shows that public expenditures constitute the main variable explaining the growth of non-oil output. Moreover, their influence has increased over time. See Box 2.

Box 2: A relationship between non-oil output and government expenditures

The association between the growth of non-oil output and oil revenues, referred to in the text, does not amount to a relationship. The influence of oil revenues stems from the expended part of the revenues, i.e. the budget expenditures. Therefore, the actual relationship is between public expenditures and non-oil output. The following econometric estimation1 using data for Saudi Arabia indicates that growth in public expenditures (capital and current) has been the main source of non-oil output growth:

V= 12191  + [0.21 l  + 0.41 (1-l)] Xt,     R2 = 0.76,

t = 1970, …, 1999,

t- value            (4.0)        (8.7)

   l =

1,      1970 – 1982

D-W = 1.4

0,       1983 – 1999

WhereVt: non-oil value added  (GDP less crude oil, natural gas and refining), million Riyals, 1970 prices.

Xt: government expenditures, million Riyals, 1970 prices.

These results may also hold for other Arab oil producing countries. They show that variations in the public expenditures explain 76% of the change in non-oil output. This is a high contribution. Besides public expenditures, other influencing variables are also at play, such as private investment and consumption, but even those are greatly influenced by public expenditures.  In addition to some limited policy influences the remaining variables relate to the inertia of the economic system .2, 3

From the estimated equation we can see that the influence of the public expenditures was much higher (twice as high) in the second than in the first period. At the time when expenditures were increasing fast, their influence on non-oil output was restrained by physical, administrative and logistical constraints. Then, this was referred to as absorptive capacity. When oil revenues started to fall after 1983 the influence of the expenditures doubled. During this period the financial constraint became the binding factor.

1 See table (11) for the details of estimation of the parameters of this equation and other equations.

2 Lags and leads in adjustments as well as physical, administrative and other types of constraints.

3The influence of the inertia can be measured through the inclusion of the lagged dependent variable Vt-1 among the regressors, also carried out in table (11). Note that though D-W=1.4 is above the critical value dU (dU = 1.3) which indicates no autocorrelation; its closeness to dU still points indirectly to the influence of the inertia. The estimation in the text, however, could still be acceptable since the estimation with the lagged variable constitutes a difference equation the solution of which shows Vt as a function of Xt only.

This is a fundamental problem facing the oil producing economies. It is obvious that the oil connection has been the major driving force of economic activity for the last five decades. Breaking away has proved unexpectedly difficult.

Looking at the experience of other countries, mostly East Asians, China and Vietnam as well as countries in Latin America we find that major sources of fast growth are external, mainly export-led stimuli. The main vehicle is the export of manufacturing goods. Auxiliary sources such as tourism and financial service also played a supportive role.

It is clear that both groups have not been able to realise sustainable development. No doubt two countries have invested part of their surpluses in portfolios that seem to produce sustainable long-term return (UAE and Kuwait).  As a matter of fact the UAE is anchoring its long-term policies on lengthening the time span during which these investments produce enough return for future generations. Apart from these two, the others, with their existing mode of social and economic organisation and perceived or actual reform programmes have not been, yet, on course to achieving this elusive target.

III. The public enterprises

Composed mainly of inward looking activities, non-oil-based public enterprises in the non-Gulf countries have long been a source of inefficiency, which has been manifested into two outcomes. First, mounted losses, arrears and debt resulted in heavy drain on resources from the budget and foreign exchange. Secondly, the deterioration of quality and quantity of their products, which in turn has been rendered by a system of quantitative protection, without which the enterprises would not have been able to survive. The interplay between the budget, public enterprises, exchange system and financial sector is revealing:

(1)   Apart from insurance companies and pension funds the banking sector has been the main financial intermediary and conduit in the country.  Its major function is to finance the operations of the state, i.e. the budget and the public enterprises.  The central bank ensured the financing of the budget deficit through treasury bills, or other special arrangements. The main task of the other banks is to finance the public enterprises at low (usually negative real) interest rates.  As a result the public debt accumulated on the part of the treasury and non-performing loans and arrears on the public enterprises increased.  The banks’ solvency diminished.

(2)   The burden on the budget mounted. This includes servicing its debt to the central bank, subsidising losing enterprises and paying the banks for non-performing loans and arrears on the public enterprises, in the end worsening the deficit further. Algeria went through all these stages especially before, and to a lesser degree after 1994.

(3)   During the eighties the exchange restrictions, motivated by low oil revenues and supporting overvalued exchange rate, constrained supplies of imported goods. Shortages were widespread. With the absence of alternative supplies, surplus purchasing power accumulated in the form of idle balances with the households.  The lending to the budget and public sector on the one hand and shortages of supplies on the other contributed to the crowding-out of private investment.[14] When alternative supplies appeared, outside the official channels, parallel markets developed in currency and goods.  Accumulated balances, with the households, found their way to these markets supporting much lower parallel rate of exchange (and hence higher inflation).

(4)   The industrial public sector has increasingly been dependent for its inputs, spare parts and capital goods on the public import (foreign exchange) budget.  This budget performed dual functions.  First it was the means by which quantitative restrictions (protection) on imports are articulated[15].  Allocations are drawn-up in the budget on the basis of importing those goods, which are not adequately available from domestic sources.  The other task is to control the current account balance. The budget is largely executed at official rate(s) of exchange.

(5)   With the segmentation of the market (official, parallel) the public enterprises could not meet their unsatisfied needs (inputs, spare parts, etc.) from the domestic parallel market, because of inflated prices. The pricing of their own products is regulated by administrative procedures; prices are set on the basis of costing at the official rate of exchange. This has accentuated the already acute problems of capacity under-utilisation, overstaffing, power cuts, etc.

(6)   Losses therefore climbed further, thus increasing arrears and non-performing loans.

Initial oil wealth, and it seems ideology, made such practices tolerable. It cannot be, a priori, explained by vested interests.  The same interests could have been served by export-oriented industries, the case with the chaebols-type[16] arrangement in the Asian experience attests to this. Dutch disease symptoms of overvalued rate of exchange, high labour unit costs and the separation of international from domestic pricing could have also been responsible, on the economic side for this pervasive situation. Furthermore, the preservation of overvalued rates of exchange at the time when the growth of the parallel markets was an indication for the necessity of devaluation is a sign of the higher priority given to social considerations over economic management.

By contrast, the more conservative currency arrangements, which are followed by all Gulf countries, stipulate full foreign exchange (usually the US $) coverage of issued currency. Central Bank (or Monetary Authority) lending to the treasury is usually prohibited by law, and adhered to in practice[17]. These arrangements blocked the way for money creation to meet the deficit of the budget.  Deficit has been met by liquidating foreign assets and borrowing from public financial organisations and commercial banks. The other public enterprises (downstream oil or public utilities) borrow from the private sector in the same way as the private sector does[18].

IV. Reforms in a changing world

The period during which reforms have become a serious choice in major Arab oil countries (1986-) has witnessed major developments in the world, mainly:

(1) Expansion and liberalisation of trade and the advent of the WTO.

(2) Liberalisation of capital movements.

(3) The fall in the costs of transportation and communications. The latter has also been signified by the spread of the use of the Internet (e-commerce, electronic money, etc.).

(4) The increasing influence of the trading blocks and supra-national groupings and trans-national corporations on the economic and political decisions of the small countries.

(5) The collapse of the East European systems.

In their different manifestations, these developments have presented various countries with different challenges. Growth has been accomplished successfully in different parts of the world.  Many countries have adapted well to the changing world, in terms of technology and competition. In addition to fast growth some of them realised more equality in income distribution (World Bank 1993)[19]. Yet, due to different endowments of management and labour skills, technological capabilities and stage of development, available indications point to increasing income disparities between nations (R. Wade 2001).  If not taking the necessary and difficult steps to catch up, the Gulf and non-Gulf countries, once in the middle to high-income scale among nations (WB classification), may find themselves increasingly lagging behind.

IV.1 The oil cycle

Since the nationalisation of most oil concessions[20] in the beginning of the seventies, crude oil started to flow increasingly outside the channels of the major integrated oil companies.  Towards the end of the seventies oil spot markets emerged in many areas around the world.  Crude oil started to look like other commodities.  After long time of constant (so-called posted) prices, fluctuations became a daily matter.[21] Indeed, in different times since the seventies the price seemed to have come close to its marginal cost in the Middle East[22] then to shoot up above that of the highest existing producing areas (the offshore North Sea or Arctic fields).

As a matter of fact looking at the price data of crude oil from the middle of the seventies to 2000 (chart 1) a kind of a cycle can be figured out. The cycle is more pronounced when monthly data is plotted (chart 2, on page 18).  It is true that the cycle is not regular, the amplitude, duration and phase are all different between one cycle and the other, but visually there are cycles all right.[23] Moreover, it is possible to articulate the different forces that could perpetuate the cycle, which will be touched on shortly. The amplitude of the first cycle (started in 1978/1979 and ended in 1986/1987) was about 22 US $ a barrel. This was followed with a cycle that started in 1989 and ended in 1996 with an amplitude of 8 US $ a barrel. The present cycle that started with a crash in 1998 then sharp rise in 2000, more or less maintained so far in the first half of 2001, has not completed its duration yet.  The amplitude is comparable to that of the first cycle.

Some of the previous cycles were associated with political or economic upheavals.  The sharp rise of 1973, 1979/1980 and even the short-lived rise of 1990 were all associated with crises in the Middle East. The current cycle cannot be explained by upheavals in the Middle East. Rather, it is the confluence of anticipated long run supply shortages (at least on the part of the Americans) and political realisation that low oil prices is destabilising to the Gulf countries. The higher the oil prices the better the chances that areas outside the Middle East can be developed (Caspian or Arctic site in Alaska) and the lower the dependence on the oil of the Middle East.

          Chart 1: Price of Brent Crude (Annual Average, US$/Barrel)

Very recently environmental considerations took a setback with the decision of the new American administration to take measures to increase supplies of crude oil and products[24]. It is obvious that the current rise in oil prices encourage these developments.

Here we have two opposing forces. On the one side the increasing dependence of the USA on imported oil,  security of supply considerations and long lead time between investment and increase in capacity, all exert upward pressures on prices. Therefore, short of a revolutionary backstop technology the price of crude oil is not expected to be driven to its marginal cost permanently, in the foreseeable future. On the other side, new supplies of oil exert downward pressures. Thus there is no way (as OPEC has been discovering time and again) to maintain a price permanently above the marginal cost by a big margin.  Oil price will, thus, continue its cyclical behaviour. With amplitude as high as ten dollars the oil producing countries will find their economies swinging accordingly.  At the downturn restructuring is defended only to be relaxed in the upturn. However, with growing population this state of affairs is obviously unsustainable. The relief of year 2000 (most likely continuing into 2001) will not last. Structural reforms are becoming a pressing need.

IV.2 Reforms and restructuring programmes

IV.2.1 The general trends

For different reasons, reform and restructuring have been pushed to the fore especially during the nineties in the Arab area (Middle East and North Africa). Though the process was overdue since the middle of the eighties it only ripened in the nineties due to the following:

(i) In some Gulf countries, mainly Saudi Arabia, and to a lesser extent in Oman and Bahrain, albeit the balance of resources has started to fall short of demand since the middle of the eighties, by the middle to the end of the nineties the situation became untenable.  More serious measures were needed.

(ii) In the non-Gulf oil states the imbalances have for long been handled through a range of wide restrictions. However, the inefficiency of the public sector and accumulating losses and budget deficit have reached a crisis point (e.g. Algeria) by the beginning of the nineties. The change of ideology that has been associated with the globalisation process bolstered by the fall of the East European systems has lent support to the turnaround from the interventionist policies.

Thus, the confluence of events made the nineties, during which the globalisation term gained its fame, a period whereby reforms are, or intended to be, applied across the Arab world, with varying speed, of course. The urge to reform has differed among Arab oil countries. Urgency is measured by the need to finance the balance of payments deficit and internal gaps in resources, on the one hand, and the size of foreign assets on the other.  At one end Algeria, short of adequate foreign exchange reserves, was forced to adopt a relatively sever IMF-supported reform programme. At the other end UAE, with ample foreign assets and no impending imbalances, implemented reforms in its trading, banking bureaucratic and judicial systems in order to attract more foreign business.  At the middle Saudi Arabia has been alarmed at the depletion rate of its foreign assets, hence started its own moderate reform programme in 1998,  (Box 3).

IV.2.2 Reforming the public sector

The continuing losses, liquidity problems and mounting debt in many of the public enterprises and their consequences on the banking system (as referred to above) have adversely affected the implementation of social policies, public and private investment programmes and privatisation efforts. Even in better-suited economies of East Asia the relationship between the banking system and public (or publicly favoured private) enterprises has led to sever financial crises (1997-1998) that affected growth negatively (Finance & Development, June 1998 and March 2001)

In these circumstances, reforms in the shape of gradual and balanced programmes of restructuring and privatisation of public enterprises and banks, more liberal practice in pricing, rate of exchange setting, etc would contribute to the unravelling of this vastly inefficient entanglement. However, the extent, domain and sequencing of reforms can be tricky, Algeria is a case at point. Growth improved slightly (but unemployment rose) after 1994’s restructuring of public enterprises and banks. During 1990-1994 annual GDP growth averaged – 0.9%, inflation 27% (CPI) and unemployment rate 22.4%. In 1995-1998 annual GDP growth averaged 3.3% (non-oil output, 2.3%) inflation 9% and unemployment rate 28.3%, (table 10 and IMF, IFS 2000).  The public sector, however, continued its losses and debt and public banks their lack of liquidity. Algeria is poised, therefore, to implement more drastic measures.

In the Gulf countries, apart from public utilities the public sector was mainly composed of hydrocarbon-related industries.  This includes oil products, gas liquefaction and primary petrochemicals[25]. The following factors may have spared the Gulf countries some of the consequences of the vicious cycle of public sector-banking inefficiency that plagued the non-Gulf countries:

(i) The currency arrangements that emulate the currency boards’ rules.

(ii) The open trading system.

(iii) The absence of protected public import substitution industries.

(iv) Private banking with reasonable regulatory framework[26].

More banking reforms are recommended by international institutions (IMF) in these countries, i.e. adopting sound practices and prudential regulations, the deepening of the intermediation process and the creation and opening up of the exchange houses to the outside world.  This can be useful as well as destabilising.

IV.2.3 WTO membership

Apart from Saudi Arabia other Gulf countries are all members in the World Trade organisation. Saudi Arabia and Algeria are negotiating their way for membership; currently they are observers.

The World Trade Organisation has not included crude oil and oil products, explicitly, in its reciprocal treatment negotiations, yet. They are still virtually traded freely across borders. On this score membership would not have much effect in the short to medium terms. The main expected present and future advantage of membership, therefore, is to be party to the changing rules of trade, services and capital flows within in the WTO. For the Gulf countries, this does not entail serious restructuring of the economy or extreme departure from present policies and institutions. It can be carried out through the undertaking of certain changes[27] while continuing with the present dependence on oil and oil-related activities. With their liberal open system, the Gulf countries are able to adapt themselves to such obligations as intellectual property rights, technical barriers to trade, etc.

For Algeria the main objective and, therefore expected advantage is to gain access to a wider market, which is necessary to promote the development of non-oil export-oriented industries. Opening its markets to trade in goods and services as well as capital would expose it, on the other hand, to a challenge that it needs to face in order to build its base for economic sustainability.

V. Future configurations

Most countries in the region are now going one way or the other for some reforms and restructuring with mixed intentions and results.  For Kuwait and UAE there is still no immediate economic reason to change the structure of the economy than the one going on now, mainly relatively liberal economic systems in possession of huge reserves, invested in foreign assets, with a highly regulated and segmented labour market. As a matter of fact the UAE is planning for the preservation of its foreign assets in real value as insurance to sustain future generations.  Political uncertainty aside, Kuwait is following the same path. The sustainability of this position can be buttressed by more diversification in services and financial management.  Even some kind of tourism can be developed. Further restructuring in banking, financial institutions (e.g. more prudential regulations), labour market, bureaucratic and judicial systems may also need to be implemented.  In this respect Kuwait and UAE have already been integrated in the global system.

Other Gulf countries are still searching for a sustainable base of development. The oil cycle will only give intermittent stimuli to growth.  With the expanding population and growing needs these stimuli will increasingly become less effective. For countries such as Oman and Bahrain the first is opting for definite lines in industrial development and services the second for financial and regional services.

Saudi Arabia may face a dilemma, or it is already exposed to. The level of national consumption (including defence) has not been subjected to drastic decline (in real terms) similar to that in non-Gulf countries, as required by the fall of resources. In this case Saudi Arabia may find itself increasingly unable to maintain the current level of consumption.  That is why it needs to face important change. For economic activity cannot sustain the financing of continuous current account deficit that was only halted in year 2000 due to high oil price.  In recognition of this, Saudi Arabia started to think about reforms, the main elements of which are spelled in Box 3. However, even if implemented, which is a departure from current policies, they may prove insufficient. Moreover, Saudi Arabia is now relatively less endowed with foreign assets, and the size of its population with respect to oil export is much bigger than in other major producers in the Gulf (table 12).  The country needs to seriously tackle such questions as:

–        What alternative lines of foreign exchange earning should be promoted? Is non-oil manufacturing a possibility?

–        Is the ongoing rate of exchange congruous with sustainable growth, is it not overvalued?

–        Is it possible to support the present size of expatriate labour force (relatively cheap labour compared to domestic labour)?

It is worth noting that the Gulf countries present an interesting outcome of a long adopted policy, which is of relevance to ongoing packages of reform.  For the best part of the second half of the twentieth century they have been following cautious monetary policies.  As referred to above their currency-board-type arrangements have spared them some of the ills that befell interventionist countries. However, with all the real or perceived efficiency gains from monetary austerity, aspired to now by many reforming countries in the Arab world and elsewhere, most these countries are still heavily tied to oil. Apart from portfolio investments (a historical incident not available any more to many oil countries in the region) regional financial and free trade areas, the rentier structure is still dominating.

The main conclusion in this paper is that the success of the restructuring programmes in finding a sustainable alternative to oil depends on the other endowments (resources, technological and managerial skills, knowledge, etc.).  No doubt that these endowments can be enhanced through education and training, but this is a medium- to long-term process.  Regional cooperation can also be beneficial, to serve this purpose, given that it is based on more solid grounds than the ongoing schemes. Countries, like Algeria, are more suited to find a broad based diversification in manufacturing and tourism, given that political stability and social peace can be attained.  The Gulf countries would not be able to find their way through this course.  Efficiency can be achieved through better use of resources, continuing with the development of chemical industry, financial services and a kind of tourism.  But apart from this type of diversification, the Gulf countries will continue their dependence on oil. UAE and Kuwait have their portfolio investments, to smooth out the ups and downs of the oil revenues, so does, to a lesser extent, Saudi Arabia. The latter, however, may increasingly resort to more serious measures and find itself in search for more viable alternatives.

By contrast poor-resource countries such as Egypt and Tunisia are trying to find a way to increase their manufacturing exports through association with Europe, the United States and membership in WTO.  Tunisia is the better of the two. Its manufacturing exports increased by 17% annually between 1985 and 1995.  Egypt may have not done so well with a rate of growth of about 7.5% annually, (both measured in US $ in current prices[28].

Box 3: Reforms and restructuring programmes, Saudi Arabia and Algeria

Saudi Arabia: Measures introduced or underway starting with 1998 reform measures

Reforms Adopted

  • Supreme economic council, chaired by the Crown Prince to oversee the implementation of the reforms programme.
  • Setting up of Saudi Arabian General Investment Authority, adopting foreign investment law and opening stock market to foreign investors.
  •  Corporatisation of telecommunications and electricity sectors and adopting privatisation strategy.
  • GCC customs tariff unification to be implemented by March 2005.
  • Real estate law: to allow foreigners to own real estate.
  • Creation of fund for training of Saudi nationals partly financed by the private sector.

Reforms under consideration

Fiscal Reforms

        · Income tax law and introduction of excises and indirect taxes.

        · Strengthening of customs and tax administration.

        · Civil service reform.

Other reforms under preparation

        · Company, sponsorship, agency, capital market, competition, labour and mining laws.

        ·  WTO accession: trademarks and intellectual property law; removal of ‘technical barriers’ to trade.

Other developments

By June 2001 an agreement concerning the development of natural gas and petrochemical processing have been finalised with foreign companies.

Algeria: IMF-supported reform programme 1994-1998: measures and reforms

Exchange Rate

  • Depreciation of the Dinar in April/September by 43% against the US Dollar.
  • Introduction with managed float regime.

Trade and Payments Liberalisation

  • Liberalisation of imports and elimination of prohibitions on the exports of a list of goods and restrictive practices on some payments.
  • Reduction of the maximum customs duty.

Price liberalisation

  • Elimination of controlled profit margins on some goods and activities.
  • Freeing of agriculture and houses’ construction pricing.
  • Elimination of generalised consumption subsidies

Public enterprise reform and private sector development

  • Liquidating 240 small public enterprises, granting autonomy for 10 food importing companies, drawing-up restructuring programmes for others and preparing a list for the privatisation of 270 local enterprises.
  • Adoption of amendments to the privatisation law to provide more flexibility.
  • Introduction of new investment code allowing foreigners participation in banks and other activities.

Monetary and financial sector reforms

  • Elimination of ceilings on bank lending rates and introduction of minimum reserves requirements. Also introduction of open market operations and auctions for central bank’s credit and treasury bills.
  • Financial restructuring and recapitalisation of public commercial banks.
  • Creation of the commission on stock market organization.

Public finance

Increasing the tax revenues by broadening the coverage of the VAT (including oil products) and increase the rates on invested profits and excise duties.

Social Safety net and social issues

Introduction of unemployment insurance scheme and public works scheme.

Chart 2: Price of Brent Crude (Monthly Average, US$/Barrel)


Adelman M., 1972, World Petroleum Market.

Findlay, R. and M. Lundahl, 1999, Resource-Led Growth: A Long-Term Perspective, The United Nations University, July.

Finance & Development (IMF) 1998The Asian Crisis, June.

Finance & Development 1999, Transition: Achievements and Challenges, June.

Finance & Development 2001Reform and restructuring in Asia, March.

IMF, International Financial Statistics (IFS) Yearbooks, 1988 and 2000.

Johnston, J., 1984, Econometric Methods, McGrraw Hill, Third Edition.

Krugman, P and L. Taylor, 1978, Contractionary Effects of Devaluation, Journal of International Economics, 8.

Little, I. M. D., R. Cooper, W. Max Corden, S. Rajapatirana 1993, Boom, Crisis, and Adjustment: The Macroeconomic Experience of Developing Countries, Oxford University Press.

Mansoob Murshed, S, 1999, A Macroeconomic Model of A Developing Country Endowed with a Natural Resource, The United Nations University, September.

OPEC, 1999, OPEC Annual Statistical Bulletin 1999.

OPEC, 2001, OPEC Monthly Bulletin March 2001.

Sachs, J, 1996, Resource Endowments and the Real Exchange Rate: A Comparison of Latin America and East Asia, Paper presented at the 7th Annual East Asian Seminar on Economics, Hong Kong, June.

UNDP: Human Development Report 1997, eradicating poverty.

UNESCWA, Economic and Social Commission for Western AsiaStudies on National Accounts in the ESCWA Region, December 1993 and July 1997.

UNESCWA and Arab Industrial Development and Mining Organization (AIDMO) 1997, Bulletin of Industrial Statistics for the Arab Countries.

Wade, R., 2001, Winners and Losers, The Economist, April 28th – May 4th.

World Bank, World Development Reports: 1996 from plan to market1997 the state in a changing world and 2000/2001, attacking poverty, Oxford University Press.

World Bank, 1993, The East Asian Miracle, Economic Growth and Public policy, Oxford University Press.


[1]  The paper benefited from comments by Dr. K. Mahdi on an earlier draft.

[2] These economies were liberal in comparison to those of the other group. However, certain market distortions have also been prevalent.  Subsidies to consumers and business sometimes outweigh those in the other group of economies.  Moreover, certain families and social groups are in command of strong manipulating and monopolistic powers.

[3] The share of the public sector in non-oil output increased in S. Arabia from 29% in 1970 to 43% in 1977, (calculated from tables available in, the web site of the Saudi Monetary Authority).

[4] Formally, the exchange regime in all Gulf countries is described as “other conventional fixed peg arrangements” (IMF, IFS Yearbook 2000). However, as referred to below the type of monetary policy followed by the Gulf countries makes the exchange regime closer to a currency board arrangement.

 [5]One important aspect of devaluation in a resource-based economy is worth mentioning.  Due to the high share of imported inputs in the cost of manufacturing a palpable devaluation may result in a substantial rise in cost, thus constraining, on the supply side, the potential for export and growth. On the domestic demand side this may also be exacerbated by the low elasticity of demand for imports. Consequently in the short run, devaluation may reduce the ability of the manufacturing sector to grow and compete in the world market. Therefore, without serious concerted efforts on restructuring and implementation of related policy measures this is a most likely consequence of devaluation even in the medium and long terms.  See Manssob Murshed (1999), R. Findlay and M. Lundahl (1999), J. Sachs (1996), P. Krugman and L. Taylor (1978).

[6] In its efforts to maintain the price of oil, OPEC increasingly acted, since 1983, as a swing producer.  Saudi Arabia in particular bore a heavy toll (its exports fell from 9.2 million b/d in 1980 to 2.2 million only in 1985, OPEC 1999). The current accounts of the balance of payments were deteriorating. In 1986 the situation became untenable, OPEC countries were losing revenues and their share in the market fell from 79% in 1979 to 52% in 1985. Consequently OPEC production quotas (ceiling allocations) were suspended. All producers entered freely into the market. Consequently prices crashed to about US $ 7 a barrel in July 1986 (OPEC spot price of reference basket averaged US $ 32.4 a barrel in 1982)). After the reinstatement of the quota system in August, which reduced the ceilings for the rest of 1986 (OPEC 1999), prices recovered but never to the previous levels

[7]  The savings of the seventies (a cumulative surplus in the current account of US $ 170 billion between 1970 and 1982) were, thus, wiped out in the eighties and nineties. The inflow of foreign private capital (oil) only contributed less than 10% in financing the deficit. As for the borrowing from abroad, available figures indicate that during the period 1992-1998 no official borrowing has taken place; a sum of US $ 4.5 was borrowed in 1991 and later repaid in 1994 and 1995. But an external debt (wholly private) of US $ 30 billion at the end of 1999 indicates that borrowing has been growing up to 1999. It makes about 16.5% of the cumulative deficit.  In spite of this the main financier is still the liquidation of official foreign assets. A similar figure for the liquidation of foreign assets by Saudi Arabia can be derived from national accounts statistics published by UNESCWA (1993 & 1997), it appears as a negative number under the heading: “the acquisition of foreign assets in the external transaction account”.

[8] Algeria realized a cumulative deficit of US $ 10 billion in the first period (1972-1983), IMF IFS 1988. This was due to its less restrictive exchange system, high levels of consumption and investment and relatively low per capita oil exports compared to the major producers, table (12).

[9] As a matter of fact a gap between national expenditures (consumption plus investment) and the whole of GDP has invariably appeared in most Arab oil countries in some years. In Algeria it was usual for national expenditures to absorb or exceed the GDP during much of 1970-1994 until it was bound by an IMF-reform-programme to close the gap. In Kuwait the gap appeared in 1986 and 1998 and very slightly in UAE in 1999. In Saudi Arabia the gap persisted throughout 1983 to1988. It is believed here that the gap continued afterwards, see Box (1).

[10]  At the time when the current account was experiencing continuous deficit during the best part of 1983-1999, Saudi Arabia kept its nominal rate of exchange intact. As a matter of fact the real rate appreciated during this period from 3.5 to 2.9 riyals to the US $ between 1983 and 1999 (using relative prices of CPI to import price index, 1983=100, in the calculations).  Social stability must have figured prominently in the minds of policy makers.  The way of life could have been much different from other Gulf countries had the Saudis devalued the rate of exchange or imposed exchange restrictions.

[11] In addition to food subsidies, imported and publicly produced goods (with high imports’ content) were also channeled to the consumers at prices based on official rates of exchange in non-Gulf countries during the second period. This was a form of subsidy compared to the prices in the parallel markets. Increasingly these channels were drying up due to three developments. First, the increasing ‘leaks’ of goods from these channels to the parallel market. Secondly, cutting on supplies due to budgetary measures (in the foreign exchange budget). Thirdly narrowing down the price differentials between the official and parallel markets by raising mark-ups on official prices and applying lower rates of exchange.

[12] However, in Algeria the change was minimal, the share only rose slightly from 70% in 1975 to 72% in 1999 (table 7).

[13] Comparing the growth of real non-oil output with real oil output (i.e. current oil output deflated by its price) is not very rewarding.  Quantitative growth of oil output has fairly weak relationships with other parts of the economy.  The stronger relationships stand on two grounds: (1) financing internal activities, mainly through the budget, (2) financing imports. For the purpose of the comparison at hand, the best measure of real oil output, is to deflate the current valued added of the oil sector by the price index of imports. See table  (9). It is worth noting here that the UAE uses this deflator to measure the real changes in the output of the oil sector. Of course the quantitative measure, can also be beneficial for other comparisons, e.g. in measuring the magnitude of physical change, the forward and backward linkages with other sectors in the economy, etc.

[14] This is in contrast to the crowding-out mechanism in open economies whereby public borrowing drives interest rate up, thus discouraging the private sector.  In the present case the rate of interest is fixed, but shortages and banking practices were insuring the same outcome.

[15] Enforcement of the quantitative restrictions is of course carried out through licensing systems.

[16] Chaebols are found in South Korea. They are groups of companies, each controlled by one family. Similar forms and arrangements are also prevalent in Indonesia.

[17] Moreover, developments in domestic interest rate (e.g. deposit rate) in S. Arabia, Bahrain and UAE usually follow the Dollar’s interest rate.

[18] It is interesting to note that the absence of public banking is not a guarantee against cheap finance to preferred enterprises as attested by the East Asian case.  One of the main causes of 1997/1998 financial crisis is thought to be cheap loans granted to state-supported conglomerates in such countries as South Korea and Indonesia, see Finance and Development June 1998 & March 2001.  On the other hand, and as a matter of fact cheap financing contributed to the fast growth of the region in the preceding three decades.  The authorities were using cheap finance as incentives or rewards to firms achieving preferred targets, mainly high exports, see World Bank (1993).

[19] In others, mainly Russia and countries in the former East European block, GDP deteriorated, poverty increased and income distribution worsened (World Development Reports 1996 and 1997 and Finance and Development, June 1999).

[20] And before that the involvement, in the sixties, of the so-called independent oil companies, in the Middle East and North Africa.

 [21] One observer in the seventies even predicted that crude oil would become an ordinary commodity with the disintegration of the integrated chain of major oil companies.  Consequently, the price of oil would be determined by the marginal cost of production. See M. Adelman, (1972). The marginal cost according to Adelman includes annualised development (and exploration) costs.

[22] See footnote 5.

[23] It was not possible to estimate statistically significant parameters for a sinusoidal function. The reason is the variability of the relevant parameters.

[24] These measures are reflected in an energy programme recently announced by President Bush on May 16, 2001. The measures aim to ‘increase the supply of energy’ the main components of which relate to crude and gas, refining, power grids as well as nuclear plants in the United States. The programme divides into two main areas. First, easing regulations on the use of fossil fuel and nuclear power and encourage the explorations for crude oil and gas (e.g. opening up 8% of the Arctic National Wildlife Refuge in Alaska, for oil and gas exploration). The second pertains to offering tax incentives to promote conservation and use of efficient, renewable and environmentally clean fuel. It is worth noting that in order to encourage exploration activity in such high-cost area, maintenance of current oil prices is expedient. For crude oil production have long been on a declining trend in the USA.  For instance it declined from b/d 8.3 million in 1979 to 5.9 million in 1999. On the other hand  imports have been rising.  Net imports of crude oil and products increased from b/d 7.8 million in 1995 to 9.2 million in 1999 (OPEC 1999).

[25] Although following a relatively liberal system in economic management, the role of the public sector is dominant in Saudi Arabia. Its share in GDP is about 60% (1999). In the non-oil sector it has increased from about 29% in 1970 (to 43% in 1977) to 42% in 1999, (calculated from tables available in

[26]  However, Souk Al-Manakh (stock exchange) crisis of 1980/81 in Kuwait has demonstrated a major weakness in the regulatory framework of the banking system in the Gulf, in general. At the time the banks effectively fueled the rocketing of the shares’ prices before the balloon burst into wide bankruptcies.  Since then better regulatory framework has been in place.

[27] Mainly: agency laws, service sector competition, subsidies to private industry, property laws, employment and segmented labour market, public sector contracts, etc.

[28]  Figures are from UNESCWA & AIDMO (1997). It is worth noting that experience shows that some resource-poor countries have been more successful in diversifying their sources of growth and foreign exchange earnings than some of the resource-rich, mainly oil, countries, see Findlay and Lundahl (1999) and Mansoob Murshed (1999).

*) Chief Technical AdvisorUNDESA/UNDP

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