Economic Research Forum (ERF)

Diversification strategies for the Gulf monarchies

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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.

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