Oil-exporting countries of the Persian Gulf: What happened
to all that money?
Hossein Askari*, Mohamed Jaber
Department of International Business, George Washington University, Suite 230, 2023 G Street, N.W., Washington, DC 20052, USA
Abstract
Our objective is to assess the economic performance of Middle Eastern oil-exporting countries over the past 25 years based on their general economic characteristics (economic dependence on a depletable resource) and attendant policy requirements (transforming to a non-depletable resource-based economy). As oil-exporting countries, we assess the macroeconomic and development policies that they should have implemented and have actually implemented over time. We find that their policies have rarely been consistent with the requirements of exhaustible resource-based economies. This has resulted in a widespread misallocation of resources and a divergence from their essential goal of economic transformation.D 2000 Elsevier Science Inc. All rights reserved.
1. Introduction
In 1975, when the price of oil had more than quadrupled from its level of 2 years earlier, it was widely believed that the oil-exporting countries of the Middle East were on their way to riches that would make them the envy of the developing world. By laying claim to over half of the world's proven oil reserves, Middle Eastern countries were thought to be on their way to reaping the rewards of petroleum. Now, after 25 years, history is the judge of whether these countries have efficiently utilized their enormous wealth transfer to put them on a path of sustainable economic growth.
Our objective is to assess the economic performance of Middle Eastern oil-exporting countries. We start with an overview of their general economic characteristicsÐand attendant policy implicationsÐthat set them apart from other developing nations, we then attempt to assess their overall economic performance over the past 25 years. Finally, their
macro-* Corresponding author. Tel.: +1-202-994-6880; fax: +1-202-994-7422.
1085-7443/00/$ ± see front matterD 2000 Elsevier Science Inc. All rights reserved. PII: S 1 0 8 5 - 7 4 4 3( 9 9 ) 0 0 0 0 9 - 5
economic and developmental policies, based on their success in instituting the necessary elements of future economic growth, are assessed.
2. The fundamental differences between oil-exporting and non-oil-exporting developing countries
When comparing oil-exporting developing countries to those that are non-oil-exporting, it is easy to overlook their common attributes and objectives. For the most part, their national objectives aim for a sustainable rise in income per capita and in overall living standards, a greater level of equity among citizens, sustained growth in output, an expansion in the share of high-value added industries and services, an improvement in general educational and skill levels, stable macroeconomic conditions, and other goals that would allow them to reach the ranks of developed countries. Nevertheless, the abundance of a valuable natural resource and the substantial inflow of capital from oil exports give a distinctive character to oil-exporting countries.
2.1. Distinctive characteristics of oil-exporting developing countries
The differentiating characteristics that set oil-exporting countries apart from other devel-oping nations stem mainly from (i) their dependence on an exhaustible natural resource and (ii) the public ownership of that resource.1
In-of-itself, dependence on oil does not clearly set petroleum-exporting developing countries apart from the rest of their non-oil-exporting counterparts. A large number of developing countries are also heavily dependent on one or two (mainly agricultural) commodities that constitute the lion's share of their exports. What distinguishes the dependence on oil, however, is the exhaustible nature of the resource. Unlike agricultural products, for example, which are reproducible year after year, the production and export of a barrel of oil is a one-time transaction that cannot be regenerated from the same resources. That is, unless new reserves are continuously found, oil wealth will necessarily be depleted at some point in the future. As will be discussed below, this distinguishing feature of oil has a direct effect on the governments' developmental strategies.
The other distinguishing feature of oil-exporting countries stems from the accrual of oil revenues to the government. Although subject to some (mostly private) debate, the ownership and exploitation rights to petroleum deposits in these countries belong to the state (as opposed to private entities). Consequently, this affords the government a dominant role in the economy. A role that becomes even more pronounced when one takes into consideration the large economic rentsÐdefined as the difference between the market price of a good and its opportunity costÐthat accrue from oil.
Despite their idiosyncratic traits, oil-exporting developing countries do not form a homogeneous group. Economic differences between them are mainly due to their overall
1
The discussion in this section is based on Amuzegar's (1983) analysis of the issue.
national factor endowments and domestic absorptive capacities.2 Among other things, oil-exporting countries differ greatly in terms of the size of their oil reserves, their gross domestic product (GDP) and development levels, the size of their populations, as well as their factor and resource endowments beyond petroleum. A common distinction between oil-exporting countries is that of the low- versus high-absorbing countries. ``Low-absorbing'' oil-exporting countriesÐsuch as Kuwait, Saudi Arabia, and the United Arab Emirates (UAE)Ðare characterized by relatively small populations, large per capita GDPs, large per capita oil reserves, little arable land, relatively few complementary resources (especially water), small markets, and an acute shortage of skilled manpower. ``High-absorbing'' countriesÐsuch as the Islamic Republic of Iran (henceforth, Iran)Ðon the other hand, have large populations, lower per capita oil reserves, a large skilled labor force, other minerals, substantial arable land, relatively good water resources, and a generally more diversifiable economy.3 Although in-depth discussion about the differences between oil-exporting countries is not the object of this article, clearly, such differences make it difficult to prescribe a single developmental strategy for all. Nevertheless, certain macroeconomic policies are beneficial to all countries due to their unique characteristics.
2.2. The interpretation of national output and its economic implications
In standard national income accounting, the way to account for a country's oil production is to simply add to national product the market value of crude oil extracted at the earliest stage of production.4 This method, however, leaves the estimate of national product vulnerable to fluctuations in oil prices (especially sharp price movements) and to changes in the rate of oil extractionÐwith these effects becoming greater the larger the share of oil in the country's economy. Consequently, it is much more informative, in the case of countries that are reliant on an exhaustible resource, to reconsider the calculation of the net national product (NNP). For a country ``with reproducible capital, but no depletable resources, the most reasonable interpretation of NNP is the largest perma-nently maintainable amount of consumption'' (Askari, 1990, p. 14). Thus, for an oil-exporting country, NNP would reflect the maximum consumption level that is indefi-nitely sustainableÐi.e., even after the natural resource has been depleted. In his analysis of this subject, Weitzman (1990) shows that the ratio of the conventionally measured NNP to the theoretically correct one is inversely related to the real rate of return on investment and to the life of oil reserves. In other words, the lower the return on an oil-exporting country's investments and the shorter the expected life of its reserves, the greater the difference between the conventional measure of its NNP and the theoretically correct one. Moreover, he conjectures that achieving a favorable
post-2
In the context of this article, absorptive capacity refers of the ability of a country to absorb oil revenues productivelyÐby efficiently investing in physical and human capital. Please refer to Amuzegar (1983, p. 21) for more details.
3
For a more elaborate discussion on the nature of differences between these countries, please refer to Amuzegar (1983).
4
depletion savings rate is highly dependent on the current savings rate, the life of oil reserves, and the real rate of return on investments.5 The causal linkage between these variables is quite intuitive: In order to attain a high, post-resource consumption level, an oil-exporting country needs to (i) maintain a high level of savings during the pre-depletion period and (ii) invest these savings in high-yielding, diversified assets. Consequently, for a country to enjoy a high post-resource savings rate, it must attempt to increase both its current savings rate and the return on its invested capital. Moreover, the savings rate would vary with the expected life of oil reserves. As the life of oil reserves decreases over time, the savings rate has to increase in order to maintain the desired post-resource savings rate.
3. The implications for developmental and macroeconomic policy
In general, when contemplating the economic structure of developing countries, one cannot help but underline the pervasive role of the state in their economic activities. Whether based on theoretical economic notionsÐsuch as an aggregate ``Big Push'' developmental strategy complemented by the need to develop the countries' comparative advantagesÐor on pure political interests, governments of developing countries have, by and large, taken it upon themselves to elevate their economies to the ranks of developed countries. Oil-exporting developing countries are no exception. In fact, the accrual of substantial oil revenues to the state has had the effect of further accentuating its role in the economic arena. The presence of oil not only enlarges the role of government, but also presents it with a new set of alternative policies. In this section, a number of policy decisions facing oil-exporting developing countries are reviewed. The discussion will focus on economic policy choices that are idiosyncratic to these countries in view of their resource endowments.
3.1. Exchange rate policy
Traditionally, many oil-exporting countries have held the view that exchange rate policy is of little relevance to their economic well being. The justification for this argument has been based on the fact that oil is sold at an internationally determined dollar price. In other words, fluctuations in a country's exchange rate have no effect on the competitiveness of oil exports. Although this argument does hold some truth in regards to the countries' energy sector, it is weak when applied to the non-oil sector. The crucial need to develop a non-oil sector, as pointed out in the discussion of NNP, necessitates an appropriate exchange rate policy by the government. Moreover, it is important to point out that the pursuit of a particular nominal exchange level constitutes only part of a more
compre-5
These hypothesized conclusions (in Weitzman, 1990) are greatly influenced by the share of the oil sector in the economy. In other words, the larger the share of the oil sector, the larger is the difference between conventionally measured and theoretically correct NNP. Moreover, the larger the oil sector, the greater is the relevance of real return on investment and life of oil reserves to the attainment of a high sustainable level of consumption.
hensive policy. What is truly important to international competitiveness is the real
exchange rate. The success of exchange rate policy is therefore highly contingent on the adoption of consistent monetary and fiscal policies. Moreover, the effectiveness of such a policy is limited by the share of economic activity that is not influenced by changes in relative price levelsÐsuch as the pervasive role of government in most oil-exporting economies. In an economy where government spending constitutes a substantial percentage of GDP, the guidance offered by the signal from relative prices is largely neglected in favor of political agendas and social pressures.
The substantial rents from oil exports, their accrual to the state and the importance of the real exchange rate to the development of a non-oil sector interact in a unique way within oil-exporting countries, producing an economic phenomenon that has come to be known as the ``Dutch disease.''6 Assuming that the economy is divided into three distinct sectorsÐnamely, the oil sector, the tradables sector, and the non-tradables sectorÐthe dynamics of the disease predict that the increase in government spending (stemming from the influx of oil revenues) will lead to a shift in labor and capital from the non-oil tradables sector into the non-tradables sector. This is mainly due to two interrelated effectsÐnamely, spending effects and resource movement effects. The economic impact of spending effects can be analyzed from two different perspectives. The monetary perspective stipulates that the increase in government spending will lead to a higher rate of domestic inflation. Since in most developing countries exchange rates are fixed, this would lead to an appreciation of the real exchange rate. Inasmuch as prices for tradable goods are set on international markets, this should lead to an increase in the relative price of non-tradable goods compared to that of tradables. An alternative perspective (based on real-economy dynamics) also arrives at the same conclusion. The latter view emphasizes the differences in supply elasticities between tradable and non-tradable goods. Since one could safely assume that the supply of tradables is relatively elastic (in comparison to non-tradable goods), then an increase in government spending on both goods will have a differential impact on their price levels. More precisely, the increase in spending will have the effect of increasing the price of non-tradable goods relative to tradable goods. This effect is accentuated when the majority of government spending is concentrated on non-tradablesÐsuch as services and construction.
The change in relative prices leads to a consequent resource movement effect. Attracted by high prices and greater profitability in the non-tradables sector, capital and labor move out of the tradables sector. The highly lucrative oil sector, with its high marginal product of labor, intensifies the resource movement out of the tradables sector. Tradable goods producers thus find themselves constrained by internationally set prices, fixed exchange rates, and rising labor costs. Briefly stated, a clear outcome of the Dutch disease is that an overvalued exchange rate and a rise in the general wage level combine to erode the competitiveness of an oil-exporting country's (non-oil) tradables
6
sector. Not only so, but it severely hinders its attempts to diversify the economy away from oil.7
In view of the detrimental effects of real exchange rate appreciation on the non-oil export sector, an active government policy is needed to contain the effects of the Dutch disease. One proposal has been to establish a regime where the exchange rate would be periodically devalued in response to real appreciation (i.e., a managed float). The rigidity of such a system, it was believed, would shield petroleum-exporting countries from volatile capital movements (largely induced by the oil-sector), while at the same time allowing for the necessary adjustments in response to real exchange rate appreciation. On the down side, however, periodic devaluations would also lead to an increase in the domestic price level; so that the net effects of such an exchange rate policy are not entirely clear.8A more direct and workable policy to combat the effects of the Dutch disease is to: (i) reduce government expenditures (especially in the non-tradables sector); (ii) promote non-oil exports (through subsidies); and (iii) reduce the growth of the non-tradables sector (through taxation). By following such a strategy, the government could effectively tackle both the spending and resource movement effects of the Dutch disease, while avoiding the possible inflationary results of periodic exchange rate devaluations.
If the achievement of an equilibrium exchange rate is the ultimate objective of an exchange rate policy, then oil-exporting countries seem to be facing an additional complication. This is because traditional equilibrium exchange ratesÐwhether based on purchasing power parity or balance of payment equilibriumÐseem to be of little applicability to oil-exporting economies. In his discussion of the subject, Amuzegar (1983, p. 31) writes:
An attempt to define some form of equilibrium exchange rate is complicated by the nature of the oil-exporting countries' external transactions . . .. [If] a key
development objective is export diversification and if the present exchange rate frustrated that objective, then the present rate would not be an equilibrium one in the eyes of the developing country itself, even if the rate meets one or the other of the usual definitions. What this analysis suggests is that a broader definition of equilibrium rates that includes the competitiveness of selected non-traditional exports must be formulated for oil-exporting developing countries.
7
The causal sequence described here is contingent on a number of factors that have been considered exogenous in the above analysis. Among these factors is the elasticity of labor supply in the oil-exporting country. If the labor supply is quite elastic, then one would expect the resource movement effect to be of little significance; thus attenuating the negative effects on the tradables sector. Conversely, the tighter labor markets are, the more one would expect the country to suffer from the symptoms of the Dutch disease. Another factor affecting this analysis is the degree of openness of the economy. This is because the greater the level of protection, the less distinguishable becomes the line dividing tradables and non-tradables. Other factors that could affect the conjectured results are the degree of capital intensity in the oil sector and the variation in this intensity between economic sectors.
8
The strategy of a managed float, with periodic devaluations, is further weakened by the introduction of expectations into the analysis. In other words, if the devaluation is anticipated, the relative price differential will not be sustained at the desired level for long. Inflationary pressures, channeled through expectations, will promptly raise the real exchange rate to its original (non-competitive) level.
3.2. Resource allocation and investment policy
The responsibility of allocating the benefits of oil revenues is of great significance. This is because the entity entrusted with that task has to carefully balance the needs of the present generationÐincluding powerful political and interest groupsÐwith those of future genera-tions. Failure to take into account inter-generational equity would lead to little or no savings and to a drastic deterioration in sustainable national income.
This leads us to the first of two main decisions facing the government of an oil-exporting countryÐnamely, which entity should be responsible for investing oil revenues, the state or the private sector? If the latter is to be responsible for properly dividing oil revenues between consumption and savings, and for investing these savings wisely, then the bulk of oil revenues should be directly transferred by the government to its constituencies. In that case, the private sector would have to take it upon itself to make the necessary investments that would allow future generations to sustain an acceptable standard of living, especially as oil revenues decline. Concurrently, this would allow the non-oil sector to prosper; thereby strengthening the level of NNP and reducing the share of the public sector in the economy. Although intuitively appealing, this strategy is not without its pitfalls. For one, many developing countries do not have accurate and sufficient information about their citizens. Second, by placing the responsibility of inter-generational equity in the hands of individual consumers (and investors), the government is likely to run into a dangerous ``collective action'' problem. In other words, a number of citizens might forgo the painful, long-term investments that are needed during the early stages of development, in the hopes that their future offsprings would be able to enjoy ``free-ride'' from the investments of others. Third, private investors, especially at the beginning stages of oil enrichment, might not possess the financial sophistication needed to handle such a large inflow of funds. Fourth, regardless of the intentions and financial savvy of investors, there remains an important role for the government to play in the provision of public goods and in the mitigation of market imperfections. This roleÐwhich is likely to gain importance as oil-exporting countries reach greater levels of developmentÐwill require a substantial share of oil revenues. Although the above arguments are by no means intended to validate the pervasive role of the state in most oil-exporting developing countries, they certainly present a possible explanation for why so many governments have chosen to hold-on to their economic dominance.
The second critical decision facing the government of an oil-exporting country is whether to invest the revenues from oil domestically or abroad. From a purely financial perspective, one would advise a government to invest wherever the real rate of return on investment is greater. However, from a broader perspective, foreign investments have numerous other advantages (and disadvantages). Among their advantages are the following:
Diversification: By placing capital abroad, the government is able to diversify away a substantial portion of the financial risks associated with its investments.
Flexibility in economic policy: During periods of low, domestic absorptive capacity, and of limited domestic investment opportunities, foreign markets enable the government to bypass such constraints; while maintaining a respectable return on its investments. Attenuating the effects of the Dutch disease: As explained earlier, the negative
sector can have detrimental effects on the future of oil-exporting economies. Therefore, by diverting some of its investments to foreign markets, the government can reduce the effects of the Dutch diseaseÐmainly, the spending effectsÐon the non-oil tradables sector.
Foreign investments encompass some indirect disadvantages. Among which are (i) the political risks associated with investing in another sovereign nation and (ii) the reduced stimulation to the domestic economyÐin the case where the economy is not feeling the pressure of its absorptive limits.
3.3. Diversification from oil and industrial policy
In their efforts to achieve a sustainable future level of consumption, oil-exporting developing countries have a very strong incentive to diversify their economies away from oil. It is perhaps this incentive, more than any other, that provides these countries with the motivation to develop a healthy non-oil sector. However, a number of other important justifications do exist for the adoption of this objective. The dependence on oil exposes these countries to the risk of volatile energy prices. It is commonly held that fluctuations in oil prices lead to considerable variations in the terms of trade of oil-exporting countries. As a representative scenario, let us consider the case where the price of oil doubles. Even if a country continues to produce the same volume of oil as it did before the price hike, assuming that the oil sector is its only significant sector, its nominal GDP would increase by twofold. It is true that once the necessary price adjustments are made (i.e., after deflating by the increase in the price of oil) real GDP would maintain its pre-shock level. Nevertheless, the enhancement to terms of trade, resulting from the oil price increase, is likely to augment the welfare of citizens in the oil-exporting country (due to the relative decrease in the prices of imports).9 It is also highly probable that the wealth effects resulting from the price increase will bring the economy closer to its capacity constraints; thereby, leading to inflationary pressures and to an appreciation of the real exchange rate. Conversely, the effects of a decrease in the price of oil on the terms of trade could be detrimental. Not only are imports likely to become relatively more expensive, but wage rigidity and price stickiness are also likely to lead to substantial unemployment. The distortionary impact of this downward shock is accentuated by the ``ratchet effects'' caused by the inability of the state to sustain (nor reverse) the financing of programs that were initiated during the boom years.
Besides reducing the economy's vulnerability to oil price changes, diversification allows the country to mitigate the effects of a capital intensive oil sector on employment. A number of oil-exporting developing countriesÐespecially high-absorbing onesÐpossess a large, relatively low-skilled labor force. Therefore, an industry that is capital intensive and that
9
In this discussion of oil-exporting countries' terms of trade, the price of imports has been considered to be exogenous. However, it is easy to show that the price of imports is affected by changes in the price of oilÐ especially imports that use oil as input. In such a case, the net effect of an upward shock to the price of oil on the terms of trade is ambiguous. Consequently, any welfare gains from such a price increase are also uncertain. For further elaboration on this subject, please refer to Chap. 7 of Heal and Chichilnisky (1991).
requires a small number of highly skilled workers will not create the necessary employment opportunities that are required by nationals. Another characteristic of the oil sector is that it possesses very few linkages to the rest of the economy.10 Its ``enclave'' nature reduces positive externalitiesÐwhether in terms of trained labor or technological flowsÐthat would impact other industries and increase overall productivity. Perhaps the most powerful internal linkage created by the oil industry is fiscal in nature (due to the accrual of oil revenues to the state). This, however, enlarges the role of the state and further diminishes the role of the private sector in the process of economic development.
Accepting the need for diversification, nevertheless, an essential question still remains: What type of industries should be promoted in order to achieve a successful diversification? From an economic perspective, one could argue that oil-exporting countries should invest in industries that are compatible with their respective factor endowments and comparative advantages. Moreover, by investing in education and encouraging the inflow of technology, these countries can create a dynamic comparative advantage that would allow them to break away from their natural constraints. Viewed this way, the challenge facing oil-exporting developing countries is no different than the one facing their non-oil-exporting counterparts. Nevertheless, two factors that are intrinsic to oil-non-oil-exporting developing countries need to be pointed out. First, as discussed earlier, these countries differ markedly in terms of their factor endowments. It is nearly impossible to prescribe a fit-for-all industrial policy for both the high- and the low-absorbing oil-exporting countries.
Second, a common reaction by the governments of these countries to the inflow of oil revenues has been to focus on infrastructural development and on resource-based indus-trialization. The development of infrastructure, especially from its dismal state in certain countries, could certainly be beneficial to the rest of the economy; especially in terms of increasing the efficiency of private investments and creating a strong base for the inflow of technology. In many ways, infrastructure is a public good that an oil-rich state is expected, by its citizens, to provide abundantly. However, infrastructural development can also have some serious repercussions, some of which are: (i) the need to maintain the infrastructure using non-oil funds once the resource has been depleted and (ii) the difficulty of predicting future infrastructural requirementsÐwhich has led a number of states to enter large, long-term and high-budget projects that increase their vulnerability to oil price changes.11Resource-based industrializationÐsuch as in the case of petrochemical plants and refineriesÐhas also been the goal of many oil-exporting developing countries. No doubt, an industrialization policy focused on petrochemicals does have several benefits, including: the production of high-value added exports, the transfer and dissemination of modern technology and managerial skills into the rest of the economy, and the expansion of high productivity employment. However, the reliance on energy sector-based industrialization as a primary path towards modernization can also be perilous. For one, oil-exporting countries are not guaranteed to have a long-term competitive advantage in this area. Among other factors, such an advantage depends on the ``relative transport costs of
10 With the exception of some forward linkages, such as in the case of petrochemicals. 11
finished and unfinished products, capital construction costs in processing industries, relative costs of financial capital, relative labor costs, and external economies'' (Askari, 1990, p. 24). Second, such a strategy still subjects the economy to fluctuations in the oil market with all their attendant costs. Finally, resource-based industrialization has to be addressed within the more general framework of comparative advantage. In other words, each oil-exporting country has to carefully analyze its resource and factor endowments before embarking on such a costly industrial program.12
In the process of implementing industrial policy, many oil-exporting developing countries have relied on subsidies to achieve their goal. These subsidies have varied in type from the more generalÐsuch as the subsidization of imports through an overvalued exchange rateÐto the more industry-specificÐincluding output and input subsidies. The rational for using subsidies as an industrial policy tool is essentially the same for all developing countries. Simply stated, subsidies can be economically efficient in situations where the social value of an activity is greater than its private value; such as in the case of (i) the existence of externalities associated with the industry, or activity, of interest that are not reflected in market prices (such as learning-by-doing benefits) or (ii) the presence of distortions in market prices that prevent the efficient allocation of resources in the economy (an example of which is the effect of the Dutch disease on wages). It should be noted that both of these rationales are in conformity with a sector-specific industrial policy. A general subsidization scheme has the potential of creating severe misallocations in the use of resources and, thus, promoting inefficiencies. In the aggregate, it is important that subsidies be targeted towards the source of the desired benefits (whether they are in the form of technological gains or adjustments to distortionary relative price differentials). Sector-specific subsidies should form an integrated part of a more comprehensive industrial policyÐwith the ultimate goal of successful diversificationÐrather than being an end in themselves.
3.4. Fiscal policy
Fiscal policy consists of changes in the government's revenue and expenditure levels (and allocations), that in turn affect overall economic efficiency and income equality. In the case of oil-exporting developing countries, the accrual of oil revenues to the government highlights the importance of this economic tool in the distribution of wealth and the insurance of inter-generational equity. In his analysis of the objectives of fiscal policy for an oil-exporting country, Amuzegar (1983, p. 34) writes:
The critical tasks are to use oil revenues to achieve optimum growth and diversification without undue inflationary pressures, to spread the benefits of oil income over the largest segment of population without reducing incentives, and to correct existing distortions in the economy without creating new ones.
Achieving these goals simultaneously is certainly an arduous task. However, in order for petroleum-exporting developing countries to grow at a sustainable pace, their governments have to successfully balance the allocation of oil revenues in a manner that
12 For further elaboration on the advantages and disadvantages of resource-based industrialization, please refer
to Auty (1990).
reduces market distortions (such as in the case of the Dutch disease) and promotes the growth of the non-oil sector. Moreover, and in preparation for the post-resource phase, governments need to reduce the share of oil in their total revenues (i.e., increase tax revenues). Very few, if any, oil-exporting developing countries have a well-established, broad-based, progressive tax system in place. This not only increases the vulnerability of long-term government programs to fluctuations in the oil market, but it also limits the degree of income equity within the same generation and endangers the effectiveness of the government's role once oil has been exhausted.
4. Economic and social development over the last 25 years: An overview
Over the past quarter-century, oil-exporting Middle Eastern countries have certainly made great strides in terms of improving the quality of life of their citizens.13As shown in Table 1, most social indicators have improved markedly over time. Infant mortality has registered a substantial decline in these countries. This has been accompanied by an increase in the life expectancy of nationals and a general improvement in their quality of life. Yet it is quite notable that large disparities exist among countries. Whereas Kuwait has attained an infant mortality rate of no more than 11 deaths per 1,000 live births, Iran, with 36 deaths per 1,000, still has not reached the level of upper±middle-income countries. Similar disparities exist in terms of life expectancy at birth; with Kuwait at the higher end of the scale and Iran at the lower end.
In school enrollment, however, the same positive trend is not persistent across all countries. Whereas Bahrain, Iran, Oman, and Saudi Arabia show a positive trend in terms of primary school enrollment, Kuwait, Qatar, and the UAE have witnessed a decline in this regard. Moreover, in all countries (except for Bahrain), the percentage of primary school enrollment remains lower than that of upper±middle-income countries. In terms of secondary school enrollment, there is a strong positive trend in all countries (except for Kuwait). The percentage of secondary school enrollment is generally higher than that of upper ± middle-income countries (except for Saudi Arabia) and lower than that of high-income countries.
Over the past 25 years, population growth in oil-exporting Middle Eastern countries has been substantial (Fig. 1). In all the selected countries, average annual population growth has exceeded even that of low-income countries and, in some cases (such as the UAE), by a considerable margin.
This result is further confirmed by other indicators of populations growth (Table 2). Although, for the most part, these indicators show a declining trend over time, their levels as
13 The choice of which countries to include in this study has been constrained by data availability. For
Table 1
Infant mortality rate (per 1,000 live births)
1970 64.20 131.20 47.80 118.80 68.20 119.00 86.80 22.34 75.91 112.61
1980 42.40 91.60 26.58 41.40 41.20 64.80 55.00 12.88 52.96 98.24
1990 22.80 53.60 13.60 22.00 21.20 32.00 20.16 8.31 37.61 75.68
1996 18.40 35.60 10.90 18.30 17.60 22.10 14.80 6.36 29.84 68.04
Life expectancy at birth (years)
1970 62.10 54.80 66.11 47.37 61.11 52.31 61.11 70.85 61.80 53.87
1980 67.84 60.13 70.78 59.81 66.73 61.12 68.22 73.75 65.50 58.47
1990 71.42 66.59 75.30 69.00 70.95 68.62 73.53 75.95 68.28 61.66
1996 72.90 69.84 76.56 70.78 72.39 70.12 74.95 77.32 69.71 63.10
Primary school enrollment (percent gross)
1975 96 93 92 44 111 58 101 102.37 96.89 95.36
1985 112 96 103 76 109 65 98 101.62 103.43 100.17
1994 110 99 65 82 86 77 94 103.30 107.45 102.74
Secondary school enrollment (percent gross)
1975 52 45 66 1 52 22 33 80.29 39.98 32.91
1985 97 44 91 27 82 40 55 92.05 51.87 34.62
1994 99 69 62 65 82 55 80 104.19 61.59 50.09
Telephone mainlines (per 1,000 people)
1975 51.47 20.54 88.38 4.37 71.93 19.03 51.10 254.34 33.10 2.44
1985 167.38 26.96 129.00 29.58 194.14 71.62 150.15 391.21 64.17 3.88
1996 241.05 95.29 232.27 85.88 239.27 106.37 302.12 540.27 130.07 25.68
Source:World Development Indicators 1998(World Bank, 1998).
of 1996 are still high in comparison to other regions of the world. In Oman, for example, the age dependency ratio reached a staggering 98 percent in 1996, while the fertility rate was close to 7 births per woman (in comparison to about 3.2 births for low-income countries). Numbers for other, more populated, countries of the Middle East are also high. In 1996, Iran had a fertility rate of 3.8 births per woman and an age dependency ratio of 81 percent (vs. 66 percent for low-income countries). Moreover, Saudi Arabia's fertility rate, at 6.2 births per woman, is close to twice that of low-income countries. The reasons underlying this considerable population growth differ depending on the characteristics of the country in question. Generally speaking, in the high-absorbing oil-exporting countries of the Middle East (such as Iran), population growth during the 1970s and early 1980s has been greatly affected by lower literacy rates and the absence of active government policies to educate citizens about the means and benefits of birth control. However, higher literacy rates among current young adults (more than 90 percent in Iran), along with the active implementation of family planning programs, have had a positive role in reducing population growth and should continue to do so in the years to come. In low-absorbing oil-exporting countries, the governments' approach to the issue of excessive population growth is quite different. In these countries, the rapid growth of the indigenous population is viewed as an issue of national security. With the ratio of nationals to total population not exceeding 35 percent in certain countries (such as Kuwait), population growth is often regarded as a means of maintaining long-run political stability. Such a policy, however, could have detrimental effects on the well being of future generations. For not only does a rapidly increasing population reduce the level of income available per person, but it could also lead to a crippling unemployment problem as young adults enter the labor force at a much faster rate than the economy is able to absorb them. This problem is accentuated by the fact that oil still plays a major role in these economies (as discussed below) and employment possibilities in the non-oil sector remain limited.
In view of the considerable wealth that has been transferred to Middle Eastern petroleum-exporting countries over the past quarter-century, it would have been logical
Table 2
Indicators of population growth
Bahrain Iran Kuwait Oman Qatar
Saudi
Arabia UAE
High-income countries
Upper ± middle-income countries
Low-income
countries World
Age dependency ratio (dependents to working-age population)
1970 0.94 0.97 0.82 0.89 0.59 0.91 0.60 0.59 0.78 0.82 0.77
1980 0.58 0.93 0.72 0.90 0.48 0.89 0.43 0.53 0.73 0.76 0.71
1990 0.52 0.95 0.61 0.95 0.42 0.80 0.48 0.49 0.66 0.68 0.64
1996 0.51 0.81 0.64 0.98 0.40 0.79 0.43 0.49 0.60 0.66 0.62
Crude birth rate (per 1,000 people)
1970 38.96 44.58 46.52 49.76 33.58 47.80 35.24 18.18 31.33 39.01 31.92
1980 34.08 43.64 37.20 45.24 29.18 42.72 29.90 14.82 28.50 30.87 27.24
1990 27.46 37.60 24.80 43.72 24.66 36.28 23.76 13.73 24.29 29.13 25.22
1996 22.06 26.24 21.60 42.36 20.18 35.44 18.76 12.35 21.50 25.90 22.39
Fertility rate (births per woman)
1970 6.51 6.71 7.10 8.45 6.84 7.28 6.52 2.47 4.46 5.98 4.80
1980 5.19 6.14 5.28 9.93 5.61 7.28 5.40 1.85 3.75 4.32 3.69
1990 3.76 5.50 3.44 7.68 4.34 6.56 4.12 1.76 2.99 3.53 3.11
1996 3.06 3.80 2.94 6.96 3.84 6.16 3.53 1.69 2.59 3.19 2.78
Source:World Development Indicators 1998(World Bank, 1998).
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GDP by country
Bahrain Iran Kuwait Oman Qatar
Saudi
Arabia UAE Chile Korea
GDP per capita (US dollars)
1970 ± 355.14 3,882.16 394.31 2,506.64 623.66 4,425.85a 931.18 272.06
1980 9,034.88 2,389.93 20,940.20 6,048.30 34,077.59 16,701.00 29,323.21 2,474.34 1,642.87 1990 8,012.31 9,873.50 8,629.88 5,267.49 15,021.31 7,039.02 17,521.91 2,314.86 5,917.24 1996 9,833.66b 2,174.67 16,778.05b 6,403.57 14,971.55 7,247.17 19,743.36 5,272.45b 9,622.60b
GDP per capita (US dollar) (average annual growth rates; in %)
1975 ± 1980 17.36 10.12 13.31 18.94 18.72 21.96 9.48 28.72 23.31
1980 ± 1985 ÿ0.03 8.96 ÿ9.60 ÿ2.29 ÿ11.97 ÿ16.07 ÿ7.61 ÿ10.09 7.11
1985 ± 1990 ÿ1.42 22.57 ÿ5.33 1.20 ÿ1.80 1.48 ÿ0.79 11.28 20.89
1990 ± 1996 2.13 3.55 29.51 3.20 ÿ1.52 0.37 2.16 10.58 8.76
GDP per capita, PPP (constant 1987 international US dollars)
1980 16,366.72 4,148.52 23,091.54 4,334.05 43,622.02 15,755.04 30,867.47 5,521.45 3,428.12 1985 10,522.27 4,178.65 13,049.21 6,738.66 16,868.40 8,143.29 18,649.11 4,870.98 4,254.70 1990 10,315.34 3,736.94 10,072.49 7,357.22 16,285.42 8,280.61 16,607.39 6,403.24 6,918.24 1995 11,929.72 4,129.25 20,704.07 7,569.57 13,364.87 7,648.81 12,144.68 8,611.56 9,529.56
GDP per capita, PPP (constant 1987 international US dollars) (average annual growth rates; in %)
1980 ± 1985 ÿ8.21 0.32 ÿ10.00 9.34 ÿ16.76 ÿ12.08 ÿ9.34 ÿ2.06 4.48
1985 ± 1990 ÿ0.14 ÿ2.09 ÿ3.79 1.89 0.86 0.47 ÿ1.96 5.72 10.40
1990 ± 1995 3.06 2.08 27.45 0.60 ÿ3.70 ÿ1.54 ÿ5.90 6.16 6.62
Sources: The figures in US dollars are fromInternational Financial Statistics(IMF, various issues) and the PPP figures are fromWorld Development Indicators 1998(World Bank, 1998). The figure in italics is fromCountry Profiles(EIU, various issues).
a Data for 1972. b
Data for 1997.
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to assume that their GDP per capita would have been consistently increasing over time. One would have also predicted that by the 1990s, GDP per capita for these countries would have at least equaled, if not exceeded, that of non-oil-exporting developing countries. This, unfortunately, does not prove to be the case (Table 3). After an initial jump in nominal GDP per capita during the 1970sÐmainly due to the two oil shocksÐ its level has receded, sometimes substantially, in all selected countries (except Oman and Bahrain). In 1980, for example, GDP per capita in Saudi Arabia was estimated at US$16,701, while that of Korea (a non-oil-exporting developing country) was marked at US$1,643. By 1996, the estimates for GDP per capita were US$7,248 and US$10,641, respectively. This relatively weak economic performance is also reflected in the average annual growth of GDP per capita: With mostly negative figures during the period of 1980±1985 (and exceeding negative 16 percent for Saudi Arabia) and fairly weak growth figures during 1990±1996 in comparison to those of Chile and Korea (which have averaged an annual growth of 10.6 percent and 8.8 percent, respectively).14
Perhaps more relevant than ``nominal'' estimates of GDP per capita are those that have been adjusted for differences in relative purchasing power across countriesÐnamely, PPP estimates (in 1987 US dollars). Here again, figures for Middle Eastern oil-exporting countries are not stellar. Although, for nations such as Kuwait and the UAE, the level of PPP GDP per capita, as of 1995, is higher than that of non-oil-exporting developing Fig. 2. GDP per capita, PPP (constant 1987 international dollar) (average annual growth rates during 1980 ± 1995).
14
Growth figures for Kuwait during 1990 ± 1996 should be viewed with a degree of caution. For although averaging out annual GDP per capita growth rates over the period yields a highly respectable figure of 29.51 percent, this number overestimates the actual improvement in the level of GDP per capita that has occurred over the period. Due to the inherent vulnerability of averaging yearly growth rates given substantial variations in a particular year, the considerable increase in nominal GDP per capita from 1991 to 1992 (in the aftermath of the Gulf war) has biased the figure upward. In fact, Kuwait's GDP per capita rose from a pre-war figure of US$11,864 in 1989 to US$17,705 in 1996, thus yielding a non-compounded annual growth of about 7 percent.
countries such as Chile and Korea, the same does not hold true for the more populated countries (e.g., Iran and Saudi Arabia). Moreover, and with the exception of Oman, all of the selected countries have registered a drop in their PPP GDP per capita from 1980 to 1995. In the case of Saudi Arabia and the UAE, PPP GDP per capita in 1995 stood at less than half its level in 1980. While the estimate for Qatar in 1995 was less than a third of that of 1980. Average annual growth rates of PPP GDP per capita (in 1987 US dollars) over 1980±1995 are also anemic (Fig. 2). At the lower end, Qatar and the UAE have had average annual growth rates ofnegative6.53 and 5.73 percent, respectively. Whereas at the upper end of the spectrum, only Kuwait and Oman stand out with average annual growth rates of 4.56 and 3.95 percent, respectively.15
The generally poor economic performance of Middle Eastern oil-exporting countries is somewhat puzzling. After all, these nations have benefited from massive inflows of funds generated by their petroleum exports over the past 25 years. This was a luxury that other developing countries, such as Korea and Chile, have not had; although they were able to perform considerably better. This puts into question the economic and development policies that have been implemented by the governments of oil-exporting countries in the Middle East.
5. Economic and development policy in Middle Eastern oil-exporting countries
The economic performance of Middle Eastern oil-exporting countries has surely not lived up to the great expectations of the early 1970s. In attempting to explain this lackluster performance, it is imperative to consider the various development strategies that have been implemented.
5.1. Dependence on oil
As mentioned earlier, oil-exporting countries share a set of distinctive characteristics that, in many respects, set them apart from other developing nations; with the main differentiating factor being their strong dependence on oil, a depletable resource. In this respect, Middle Eastern oil-exporting countries are no exception to the rule. In 1980, petroleum exports constituted approximately 90 percent of total exports for the major oil producers of the region (Table 4). And with the exception of the UAE (because of re-exports from Dubai), petroleum exports, as of 1996, still accounted for more than 80 percent of their total exports. The case of Kuwait is especially notable: The share of petroleum in total exports actuallyincreased, over the period 1980±1996, to about 95 percent.
By comparing the value of petroleum exports to GDP two facts are clear (Table 4). First, and as predicted, the region's high-absorbing countries (e.g., Iran) are much less dependent on oil exports than are their low-absorbing counterparts (e.g., Saudi Arabia and Kuwait).16
15
Here again, figures for Kuwait should be considered with caution.
16
Second, within the group of low-absorbing countries, the value of petroleum exports to GDP has declined considerably over time. Nevertheless, it remains substantial. As of 1996, Kuwait's petroleum exports were valued at 45.5 percent of GDP, while at the other end of the scale the UAE's oil exports stood at 33.6 percent of GDP (again because of the growth of non-oil activity, especially re-exports in Dubai).
Although considerable dependence on oil is to be expected for the smaller, low-absorbing countries of the Middle East, the fact that even larger nations (such as Saudi Arabia) are still heavily reliant on petroleum for economic growth, after 25 years of development, is not a satisfactory outcome. High dependence on oil continues to subject these economies to the variability of petroleum prices on international markets. Moreover, recall that one of the main objectives of economic policy in oil-exporting countries is to develop a non-oil sector that would be able to reduce their economies' reliance on a single resource and would prepare the stage for a post-resource phase. To this extent, and as will be underlined below, oil-exporting Middle Eastern economies have not pursued a consistent and well-defined strategy for economic diversification.
In view of this considerable dependence on oilÐa depletable resource, one would have expected Middle Eastern oil-exporting countries to have a high savings rate in comparison to other non-oil-exporting developing countries. As mentioned earlier, a high level of savings is of crucial importance to these economies if they are to make a successful transition once petroleum has been depleted and if they are to have a respectable post-resource savings rate. Yet, here again, the figures for these countries seem to be at odds with policy requirements and expectations (Table 5). In fact, as of 1995, none of the selected Middle Eastern oil-exporting countries had a savings rate that exceeded that of East Asian and Pacific countries. Moreover, savings have actuallydeclinedconsiderably from their level in 1975. Whereas, in 1975, Kuwait, Saudi Arabia, and the UAE enjoyed extraordinary savings rates of 67.2, 67.9, and 75.9 percent, respectively, by 1995, these rates had dropped to 18, 31.6, and Table 4
Indicators of degree of dependence on petroleum exportsa
Iran Kuwait Qatar Saudi Arabia UAE
Petroleum exports as a percent of total exports
1980 94.77 91.77 94.51 99.00 88.28
1985 96.72 91.10 99.03 94.39 73.80
1990 92.75 91.36 84.13 90.35 68.55
1996 80.21 94.54 92.61 82.41 44.59
Petroleum exports as a percent of GDP
1980 12.45 66.00 68.54 69.13 65.47
1985 7.91 44.05 49.86 29.92 40.32
1990 3.33 34.57 44.47 38.34 44.13
1996 13.51 45.50 45.34 36.65 33.57
a
Where applicable, petroleum products are included. Data for some countries may include exports of condensates and other NGLs. The figure in italic is the authors' estimate.
Sources:International Financial Statistics(IMF, various issues), Balance of Payments and External Public Debt of Arab Countries(AMF, 1991/1997b),Annual Statistical Bulletin(OPEC, 1990/1997), andCountry Profiles (EIU, various issues).
27.4 percent, respectively. Ironically, among this selected group of Middle Eastern countries, the one with the highest rate of savings to GDPÐnamely, IranÐis also the one that theoretically has the least need for maintaining a high savings rate. Recall that Iran is a high-absorbing oil-exporting country; thus, its economy is generally more diversified and its dependence on oil is lower than that of its low-absorbing counterparts. Consequently, although compensation for oil depletion through savings is still a necessity in Iran, the greater size of the non-oil sector predicts a more sustainable level of consumption in the future and validates a relatively lower savings rate in comparison to countries such Kuwait and the UAE.
Of equal importance to the level of savings in the attainment of a high NNP is the efficiency with which these savings are invested. Higher returns on current investments should allow for a greater degree of sustainable consumption once oil has been depleted. On the aggregate, however, oil-exporting Middle Eastern countries have mainly concen-trated on domestic investments while reverting to foreign investment opportunities only when domestic absorptive capacities were close to their limits. Even then, foreign investments were concentrated in low-yielding, short-maturity, sovereign debt instruments. The prudent appeal of this strategy disguises its main shortcomingsÐnamely, forgone high returns on other lucrative foreign investments, and a disregard for the advantages of portfolio diversification.
With a savings rate that does not coincide with their need to ensure post-resource economic sustainability, oil-exporting Middle Eastern countriesÐespecially, low-absorbing onesÐare essentially living off the wealth of future generations. In other words, by consuming more than what it is entitled to, the current generation is maintaining its high standard of living at the expense of the welfare of future generations. The ethical and moral dimensions of this problem are far reaching. If we are to accept that the insurance of inter-generational equity is a critical part of the state's role, then nowhere is this argument more valid than in the case of these countries.
Moreover, the importance of the government's role in insuring an adequate level of savings is amplified by the accrual of oil revenues directly to the state. As custodians to their Table 5
Gross domestic savings (as a percent of GDP)
Country names 1975 1985 1995
Iran 33.72 20.96 34.06
Kuwait 67.18 29.78 18.00
Oman 52.49 40.22 26.66a
Saudi Arabia 67.92 13.05 31.59
UAE 75.90 52.96 27.44a
East Asia and Pacific countries
28.15 30.47 38.33b
High-income non-OECD countries
33.51 31.70 26.76
Source:World Development Indicators 1998(World Bank, 1998).
a
Data for 1994.
b
countries' oil wealth, the governments of oil-exporting Middle Eastern nations have assumed the responsibility of deciding how petroleum revenues should be spent (or saved for that matter). In general, governments have eschewed direct transfers to citizens. The rationale behind this has been the absence of demographic data on would be fund recipients during the early extraction phase. Although this difficulty is generally no longer the case, the state has maintained its grip on the disbursement of oil revenues. Transferring oil wealth to citizens has been achieved indirectly through subsidized prices, highly paid public sector employment (mostly in low-absorbing countries) and the provision of public goods (such as education and infrastructural development). These policies, especially the first two channels, have introduced considerable distortions into the economies of these oil-exporting countries. In view of these economic inefficiencies, governments should perhaps reconsider the idea of transferring part of the oil revenues to their citizens by means of direct payments (such as in Alaska). Previous logistic hurdles and fears of lack of financial sophistication among citizens are now difficult to validate. Direct payments to nationals would also transfer some of the responsibility for balancing current and future consumption onto individual citizens. It should be noted, however, that such a policy change would have little effect if it is not accompanied by the implementation of a cohesive government plan to eliminate many of the prevailing market inefficiencies.
5.2. The external sector and exchange rate policy
The importance of savings to the oil-exporting countries of the Middle East has immediate implications on their external account balances. In view of the considerable domestic savings that are required to compensate for the depletion of oil, one would have expected these countries to maintain current account surpluses while oil is being depleted. In the case of low-absorbing countries, their relatively small population sizes, as well as their limited absorptive capacities, offer further theoretical validation for such surpluses. Nevertheless, this does not turn out to be the case for all countries. Whereas Bahrain, Iran, Kuwait, and the UAE have all managed to keep a current account surplus during recent years, only Kuwait (excluding the effect of the Gulf War) and the UAE were able to do so consistently since 1980 (Table 6 and Appendix A). And even in the case of the latter two countries, the value of the surplus in comparison to GDP decreased from a 1980 high of 53.3 and 34 percent, respectively, to 22.8 and 14.9 percent in 1996. Saudi Arabia, on the other hand, has consistently maintained a current account deficit over the period 1983±1995. Another notable fact is that changes in the current account balance have been closely correlated with variations in the international price of oil (Fig. 3). This reflects partly the overwhelming share of petroleum in the exports of these countries and, in part, the smaller share of foreign investment income in their overall current account balance. Furthermore, current account deficits over time would have been surely acceptable had they been incurred to finance lucrative investments, but the sheer volume of oil export revenues, in comparison to the amount of imported capital goods and foreign services, casts much doubt on such a premise. It would, therefore, be safe to assume that the current account deficits are mainly due to excessive government expenditures (consumption) and high domestic absorptions.
Moreover, whereas one would have anticipated an increase in the foreign investments of oil-exporting Middle Eastern countriesÐas a result of the limited number of lucrative
domestic investments and the higher return on foreign assetsÐthis again did not happen. The general trend in the selected countries has been an increase in net foreign assets until the late 1980s, followed by either a stagnation, or even a reduction, in the level of these assets over time (Table 6 and Appendix B). For example, Qatar's net foreign assets as of 1996 were at 66 percent of their value in 1985. Saudi Arabia's net foreign assets in 1996 were at 41 percent of their value in 1985. Oman has not performed much better either; with a negative balance on its net foreign assets over the whole 1985±1996 period. The clear exceptions to this rule are Kuwait and the UAE. In comparison to their 1985 level, Kuwait and the UAE's net foreign assets in 1996 had increased by 48 and 177 percent, respectively.
By and large, Middle Eastern oil-exporting countries have not devised clear policies with the aim of channeling a significant part of their oil wealth into productive investments. For if Table 6
Exports and current account balances
Bahrain Kuwait Oman Qatar Saudi Arabia UAE
Current account balance (millions of US dollars)
1980 184.4 15,302.0 942.0 2,646.6 41,503.0 10,069.1
1990 244.9 3,886.0 1,106.0 306.3 ÿ4,152.0 8,172.2
1994 198.2 3,227.0 ÿ805.0 ÿ501.9 ÿ10,487.0 3,037.4
1995 557.0 5,019.0 ÿ801.0 ÿ1,848.1 ÿ5,325.0 4,889.7
1996 484.8 7,071.0 ÿ265.0 ÿ1,452.5 681.0 6,646.7
Current account balance as a percent of GDP (%)
1980 6.00 53.34 15.89 33.77 26.52 34.00
1990 6.11 21.04 10.50 4.16 ÿ3.97 24.29
1994 4.08 13.01 ÿ6.23 ÿ6.81 ÿ8.73 8.28
1995 11.02 18.86 ÿ5.82 ÿ24.59 ÿ4.25 12.21
1996 9.04 22.82 ÿ1.80 ÿ17.32 0.50 14.90
Value of goods exports (f.o.b.) (millions of US dollars)
1980 3,433.2 20,633.0 3,748.0 5,684.0 101,574.0 21,964.2
1985 2,896.8 10,374.0 4,971.0 3,098.0 27,478.0 14,764.4
1990 3,760.6 6,989.0 5,508.0 3,890.4 44,414.0 21,656.2
1996 4,112.8a 14,913.0 7,339.0 4,104.1 60,729.0 33,595.8
Exports as a percent of GDP (%)
1980 111.76 71.92 63.23 72.52 64.91 74.16
1985 79.32 48.36 49.71 50.35 31.70 54.64
1990 93.87 37.84 52.28 52.86 42.43 64.37
1996 81.38a 48.13 49.83 48.95 44.48 75.29
Net foreign assets (millions of US dollars)
1985 3,300 49,700 ÿ600 5,200 122,700 39,700
1990 2,200 85,300 ÿ1,100 6,300 109,500 72,000
1996 4,523 73,308 ÿ4,080 3,433 50,610 109,822
Sources: For current account and exports:International Financial Statistics(IMF, various issues). The figures in italics are fromBalance of Payments and External Public Debt of Arab Countries(AMF, 1991/1997b). For net foreign assets, refer to Appendix B.
a
they had done soÐand given the limited number of domestic, high-yielding investment opportunitiesÐthis would have been translated into a consistent increase in the value of net foreign assets, regardless of the value of oil exports during a particular year. It is safe to say that none of the Middle Eastern oil-exporting countries have an explicit savings policy in preparation for a post-resource stage.17 Moreover, one should keep in mind that returns on foreign investments are classified as exports of services in balance of payments accounting. Therefore, by increasing their investments abroad and by diversifying these investments across industries, these countries could have both augmented their level of savings and reduced their economies' exposure to oil price movement.
As a simple hypothetical scenario, we have thought to compare the actual value of net foreign assets for selected countries in the Middle East to that of a ``virtual'' fund with the following simple investment policy: Set aside 10 percent of the value of yearly petroleum exports and invest this amount in a low-risk foreign asset.18Two investment strategies were hypothetically
Fig. 3. Aggregate CA balance and oil prices.
17
Among oil-exporting Middle Eastern countries, a major exception to this rule has been Kuwait. Its government adopted a judicious strategy of placing 10 percent of oil revenues into Fund for Future Generations. This percentage, however, has not been based on a calculated analysis of the needs of Kuwait in view of its oil endowments and economic structure (see footnote 18).
18
It is important to note that the value of 10 percent is an arbitrary one. Since this ``virtual'' fund would form an essential part of the oil-exporting country's national savings, the exact percentage of petroleum revenues that need to be set aside has to be part of an overall study determining the country's optimal savings rate in preparation for a post-depletion stage. To derive a precise estimate of this rate one has to take into consideration several factors, among which are: the desired post-resource savings rate, the remaining life of oil reserves, the real rate of return on investments, and the proportion of NNP that is non-oil-based (refer to Weitzman, 1990).
chosen: (i) invest the money in US T-bills or (ii) invest the funds in long-term US government bonds.19As is shown in Table 7, the results for the selected countries are mixed. On the high end of the scale, the UAE has managed to accumulate net foreign assets with a value that far exceeds that of the ``virtual'' fundÐwhether the revenues from oil exports were invested in US T-bills or long-term government bonds. In fact, the value of the UAE's net foreign assets, as of 1996, exceeded that of the ``virtual'' fund invested in long-term government bonds by at least 88 percent. At the other end of the scale, Saudi Arabia's net foreign assets, as of 1996, were far below those of the ``virtual'' fund whether the cash flows were invested in US T-bills or long-term government bonds. More precisely, its net foreign assets were marked at 37 percent of the value of the ``virtual'' fund invested in T-bills and a mere 20 percent of the one invested in long-term government bonds. This simple exercise leaves a lot of room for one to wonder whether or not the substantial funds that were transferred to the oil-exporting countries of the Middle East have Table 7
Actual net foreign assets versus virtual funds from exports (millions of US dollars)
Net foreign assets
Virtual fund invested in US T-bills
Virtual fund invested in long-term bonds Kuwait
1985 49,700 15,090 17,598
1990 85,300 21,144 28,168
1996 73,308 28,749 49,879
Qatar
1985 5,200 4,445 5,315
1990 6,300 6,163 8,406
1996 3,433 8,636 15,189
Saudi Arabia
1985 122,700 75,754 91,864
1990 109,500 99,208 138,984
1996 50,610 135,849 246,913
UAE
1985 39,700 16,155 19,184
1990 72,000 23,360 31,354
1996 109,822 34,030 58,275
Virtual fund was obtained by compounding 10 percent of the value of petroleum exports each year beginning in 1975.
Source: For net foreign assets, refer to Appendix B. Securities returns: SBBI Yearbook 1997 (Ibbotson Associates, 1997).
19
been invested in a manner that is consistent with a policy of preparation for a post-resource stage and the insurance of inter-generational equity.20
Traditionally, governments of Middle Eastern oil-exporting countries have held the view that exchange rate policy is of little relevance to their economic well being. Consequently, and since the early seventies, these countries have opted to tie their exchange rates to the US dollar (Appendix C). This policy has some serious drawbacks in relation to the development of a non-oil tradable-goods sector. As discussed earlier, a critical factor in determining the international competitiveness of a country's exports (especially those that are non-resource-based) is the equilibrium level of its real exchange rate. However, by focusing onnominalexchange rates, Middle Eastern governments have indirectly subjected the growth of non-oil exports to the harmful effects of an appreciation in the domestic price level and to the damaging effects of the Dutch disease. In turn, this has had a negative effect on the development of a prosperous tradables sector and on the prepared-ness of these countries for a post-depletion stage. Due to the absence of reliable price indices in oil-exporting Middle Eastern countries, it is difficult to estimate the degree by which their exchange rates might be overvalued. Nevertheless, their ``weak'' current account balances combined with the still infant stage of their private, non-oil sectorÐin spite of substantial government subsidiesÐpoint to the strong possibility of overvalued exchange rates.
It is safe to say that none of the oil-exporting countries of the Middle East has a clear exchange rate policy.21 Overvalued exchange rates have not only hindered the countries' prospects for diversification away from oil, but they have also indirectly subsidized imports. To the extent that these imports are in the form of intermediate goods necessary for the development of high-value added industries, such a policy could be beneficial, but the benefits from such a strategy should be weighed against its harmful effects on non-oil export promotion. Moreover, by pegging their exchange rates to the US dollar, govern-ments have lost a critical tool of economic policyÐnamely, monetary policy. Such a handicap is exasperated by the vulnerability of their economies to changes in the value of their anchor currency. Despite the fact that the depreciation of the US dollar during the
20
A possible criticism of this hypothetical scenario is that for some Middle Eastern countries, such as Iran, foreign investments have been accompanied by a considerable degree of country risk. Although this argument is certainly valid in an international market with limited investment opportunities, it is difficult to substantiate when the explosive growth of global financial markets over the past 2 decades is taken into consideration. Admittedly, country risk will surely remain an issue to be considered; but a proper diversification of the investment portfolio along with a careful assessment of the global political situation (an area in which the sovereign investor is at a distinct advantage) could yield the same conjectured returns if not more.
21
A possible exception to this rule is Iran. Although the country does not have an explicit policy as to what its equilibrium exchange rate should be, it has at least attempted to pursue an active exchange rate policy. In March of 1993, in conformity with its First Five-Year Development Plan, the government introduced an official, unified, floating rate of about 1,600 rials per US dollar. However, under pressure from increasingly inflationary conditions, it was forced to abandon the floating rate by the end of 1993 in favor of a fixed rate system. In May 1994, the government reverted to a dual official exchange rate system; with the more ``depreciated'' rate applying to non-oil exports and non-essential imports. Yet, since this essentially remains a ``fixed'' exchange rate system, the currency has been consistently subjected to overvaluation due to the high inflationary environment in Iran.
second half of the 1980s might have helped increase the competitiveness of their exports, its appreciation during recent years can hardly be beneficial.22
Although it is clear that governments of Middle Eastern oil-exporting countries need to shift the focus of their exchange rate policy towards real exchange rates, doing so might prove to be politically perilous. Overvalued exchange rates have, up to this point, indirectly subsidized domestic consumption. Citizens have come to expect such an implicit subsidy from a government to whom oil revenues accrue. Therefore, a new exchange rate policy should be incorporated into a more comprehensive reform of the governments' overall subsidy policy discussed below.
5.3. Diversification from oil and industrial policy
The economies of Middle Eastern oil-exporting countries remain highly dependent on petroleum for growth. As discussed earlier, oil still constitutes the lion's share of their exports. Moreover, the oil sector's share of their national product remains substantial despite a decrease from its 1980 levels (Table 8).23 On average, the ``mining, quarrying, and fuel'' sector is estimated at about 40 percent of the low-absorbing countries' domestic product (down from about 65% in 1980).24
Accepting the need for diversification is only the first step in these countries' journey towards industrial development. They also need to carefully consider the types of industries that are to be promoted and the means by which their governments will carry out such a strategy. Until recently, however, industrial policy in most of the Middle East's oil-exporting countries (especially low-absorbing ones) has focused on resource-based industrializationÐ Table 8
The share of oil in the economy (mining, quarrying, and fuel sector as a percent of GDP)
1980 1985 1990 1996
Irana ± ± 8.2b 15.6
Kuwait 65.6 49.4 39.4 44.5
Oman 62.1 48.8 48.0 42.6
Qatar 67.2 42.8 38.0 36.4
Saudi Arabia 66.1 28.7 35.8 36.4
UAE 64.4 45.3 46.9 35.1
Sources: National Accounts of Arab Countries (AMF, 1991/1997d), Islamic Republic of Iran: Statistical Appendix(IMF, 1996).
a
For Iran, the figure includes oil and gas production, refining, and distribution.
b
Data for 1991.
22
For a discussion of the exchange rate policy in the countries of the Gulf Cooperation Council (GCC), please refer to Modigliani and Askari (1998).
23
By definition, the share of the oil sector in high-absorbing oil-exporting countries is smaller than in their low-absorbing counterparts. This fact is validated by the data; as the share of the oil sector in Iran (a high-absorbing country) is smallerÐand by a considerable marginÐthan it is in any of the other selected Middle Eastern countries.
24 To the extent that the main mining and quarrying activities in the selected countries are oil-related, their
