Economic Research Forum (ERF)

Diversification strategies for the Gulf monarchies

1270
For the Gulf monarchies, the only long-term solution to lower oil prices is to diversify the economy, which can be done either with or without citizen labour. This column argues that given employers’ preference for foreign labour, the only alternative is to bifurcate the job market, creating enclaves where citizen labour can be used productively. This requires strong state institutions that can impose labour market regulations on businesses.

In a nutshell

Labour market issues must be at the heart of efforts to deal with lower oil prices in the Gulf monarchies.

In the long run, most will need to restructure their economies to rely on citizen labour in the private sector.

The key measure of success will be the ratio of citizens to foreigners in the private sector job market.

Addressing the budgetary problems of the Gulf monarchies in the face of lower oil prices ultimately requires encouraging productive economic activity beyond the export of crude hydrocarbons and then taxing that activity. But such diversification raises one central question: whether it will be citizens or foreigners who provide the labour in the diversified sectors of the economy. There are essentially four options.

One approach – the Dubai strategy – is to embrace fully the use of low-cost foreign labour to build a diversified economy. This economy is then taxed, producing revenue that can be distributed to citizens via public sector jobs (though citizens today primarily rely on the state’s oil income).

Unsurprisingly, the Dubai strategy requires plentiful foreign labour: in the United Arab Emirates (UAE) today, the ratio of non-citizens to citizens is in the neighbourhood of eight to one. The diversified economy is low-wage, making any future transition to the use of citizen labour unlikely. The long-term problem with this strategy is political: it makes citizens a small but very privileged minority in their own country, living on the tax revenues generated by millions of resident non-citizens.

A second strategy is to reduce the number of citizens employed in the public sector and cut the wages of those who remain. The hope is that citizens will enter the private sector job market because they are in need of income.

This strategy is a favourite of international institutions. But it is very unlikely to work, except for the most educated citizens, if cheap foreign labour remains abundant. Instead, citizens will simply leave the labour market, sit at home and reflect on how they are not receiving their fair share of the country’s oil wealth.

Education is not the solution, except at the margins: there needs to be a place in the labour market for less well educated Gulf citizens. In countries that still enjoy substantial oil wealth, reducing the standard of living of unskilled citizen workers to that of labourers from some of the world’s poorest countries is simply not a politically sustainable option.

A third strategy is to rely only on citizen labour. This is no more likely to be adopted than the second strategy. Nevertheless it is worthwhile to conduct a thought experiment that considers the consequences of this strategy as a way of illustrating the complex interactions between labour markets, diversification, budgets and political constraints:

  • Foreign workers lose their jobs and labour-exporting countries lose remittance income.
  • Local economies retain money that would have left as remittances.
  • The state saves money that is currently spent on foreigners in the form of infrastructure, health care, policing, subsidies and the like.
  • The economy contracts sharply.
  • Businesses, by necessity, raise wages enough to attract citizen labour.
  • The cost of non-tradable goods and services increases sharply.
  • Citizen labour is used productively in the private sector.
  • Businesses seeking to produce tradable goods have a citizen labour force available that is expensive, but also productive.

The upside of this strategy is that the private sector would have no choice but to put citizen labour to productive use in the non-tradable sector of the economy. Citizen labour that is productive in the private sector might also develop the skills necessary to produce non-energy exports as well.

Moreover, the positive effect on the budget would lengthen the time that the Gulf monarchies would be able to live off existing oil wealth. The negative effects would mainly fall on foreigners and businesses, although the citizen middle class also would see a very sharp increase in the price of services.

The fourth strategy – and the one most likely to be pursued by the Gulf monarchies (apart from the UAE and perhaps Qatar) – is a variant on the third. Instead of relying only on citizen labour, the private sector labour market would be segmented, reserving some areas (usually sectors or professions) for high-cost citizen labour and other sectors for low-cost foreign labour. This achieves some of the positive aspects of the third strategy while avoiding the cataclysmic negative effects.

The strategy requires a very strong administrative apparatus that rigidly maintains the boundaries between sectors reserved for citizens and those open to expatriates. In the absence of strong institutions, politically connected businesses could circumvent the rules and hire foreign labour wherever and whenever possible. This would result in further distortions to the labour market and the creation of even more rents for the politically connected.

The strategy also does little to address budgetary problems or to use citizen labour productively. Seriously pursued, however, this is the most politically feasible solution to the labour market problems faced by the Gulf monarchies. Thus, the most important step that these states can take is to develop an administrative capacity that prevents politically linked businesses from substituting foreign labour for citizen labour.

The key measure of the success of this strategy will be the ratio of citizens to foreigners in the labour force. Ultimately, that requires reversing the trend of recent years across the Gulf monarchies, in which the number of foreigners in the private sector has continued to rise, as has the foreign share of the workforce.

Further reading

Herb, Michael (2014) The Wages of Oil: Parliaments and Economic Development in Kuwait and the UAE, Cornell University Press.

Herb, Michael (2017) ‘The Political Realities of Economic Reform in the Gulf Monarchies’, ERF Policy Brief No. 25.

Tags: , , ,

Most read

Trust in Lebanon’s public institutions: a challenge for the new leadership

Lebanon’s new leadership confronts daunting economic challenges amid geopolitical tensions across the wider region. As this column explains, understanding what has happened over the past decade to citizens’ trust in key public institutions – parliament, the government and the armed forces – will be a crucial part of the policy response.

Qatarisation: playing the long game on workforce nationalisation

As national populations across the Gulf have grown and hydrocarbon reserves declined, most Gulf countries have sought to move to a more sustainable economic model underpinned by raising the share of citizens in the productive private sector. But, as this column explains, Qatar differs from its neighbours in several important ways that could render aggressive workforce nationalization policies counterproductive. In terms of such policies, the country should chart its own path.

Small businesses in the Great Lockdown: lessons for crisis management

Understanding big economic shocks like Covid-19 and how firms respond to them is crucial for mitigating their negative effects and accelerating the post-crisis recovery. This column reports evidence on how small and medium-sized enterprises in Tunisia’s formal business sector adapted to the pandemic and the lockdown – and draws policy lessons for when the next crisis hits.

Economic consequences of the 2003 Bam earthquake in Iran

Over the decades, Iran has faced numerous devastating natural disasters, including the deadly 2003 Bam earthquake. This column reports evidence on the unexpected economic boost in Bam County and its neighbours after the disaster – the result of a variety of factors, including national and international aid, political mobilisation and the region’s cultural significance. Using data on the intensity of night-time lights in a geographical area, the research reveals how disaster recovery may lead to a surprising economic rebound.

Qatar’s pursuit of government excellence: promises and pitfalls

As Qatar seeks to make the transition from a hydrocarbon-based economy to a diversified, knowledge-based economy, ‘government excellence’ has been identified as a key strategic objective. This column reports what government effectiveness means in terms of delivery of public services, digitalisation of services, and control of corruption – and outlines the progress made to date on these development priorities and what the country needs to do to meet its targets.

The impact of climate change and resource scarcity on conflict in MENA

The interrelationships between climate change, food production, economic instability and violent conflict have become increasingly relevant in recent decades, with climate-induced economic shocks intensifying social and political tensions, particularly in resource-constrained regions like MENA. This column reports new evidence on the impact of climate change on economic and food production outcomes – and how economic stability, agricultural productivity and shared water resources affect conflict. While international aid, economic growth and food security reduce the likelihood of conflict, resource scarcity and shared water basins contribute to high risks of conflict.

A Macroeconomic Accounting of Unemployment in Jordan:  Unemployment is mainly an issue for adults and men

Since unemployment rates in Jordan are higher among young people and women than other groups, unemployment is commonly characterised as a youth and gender issue. However, the majority of the country’s unemployed are adults and men. This suggests that unemployment is primarily a macroeconomic issue challenge for the entire labour market. The appropriate response therefore is coordinated fiscal, monetary, structural and institutional policies, while more targeted measures can still benefit specific groups.

The green energy transition: employment pathways for MENA

The potential employment impacts of green and renewable energy in the Middle East and North Africa are multifaceted and promising. As this column explains, embracing renewable energy technologies presents an opportunity for the region to diversify its economy, mitigate the possible negative impacts of digitalisation on existing jobs, reduce its carbon footprint and create significant levels of employment across a variety of sectors. Green energy is not just an environmental imperative but an economic necessity.

Global value chains, wages and skills in MENA countries

The involvement of firms in production across different countries or regions via global value chains (GVCs) can make a significant contribution to economic development, including improved labour market outcomes. This column highlights the gains from GVC participation in terms of employment quality in Egypt, Jordan and Tunisia. Given the high unemployment, sticky wages and wide skill divides that are common in the MENA region, encouraging firms to participate in GVCs is a valuable channel for raising living standards.

Tunisia’s energy transition: the key role of small businesses

Micro, small and medium-sized enterprises (MSMEs) play a critical role in Tunisia’s economy, contributing significantly to GDP and employment. As this column explains, they are also essential for advancing the country’s ambitions to make a successful transition from reliance on fossil fuels to more widespread use of renewable energy sources. A fair distribution of the transition’s benefits across all regions and communities will secure a future where MSMEs thrive as leaders in a prosperous, inclusive and sustainable Tunisia.