The large and unexpected decline in oil prices since their peak in June 2014 is an opportunity, pushing politicians in the countries of the Arab region to take diversification much more seriously because of the threats to their public finances. But whatever happens to oil prices, it is not simply diversification that is needed: a fundamental transformation of Arab economies and societies is essential to fulfil the aspirations and expectations of their young and growing populations.

That was how Hafez Ghanem (World Bank) opened a two-day ERF policy conference on global oil markets and their consequences for the Arab region. Hosted by the Arab Fund for Economic and Social Development in Kuwait, the event brought together international experts, regional researchers and policy-makers.

Discussions included the medium to long-term outlook for oil prices (whether we are in a ‘new normal’ or ‘new global oil order’); how fiscal and monetary policies should respond; the role and strategies of sovereign wealth funds; diversification and structural transformation; and the longer-term reforms needed to achieve sustainable development – not least significant changes to education systems, the position of women and the size of the private sector.

The oil market outlook

Kamiar Mohaddes (University of Cambridge) noted that as with all markets, lower oil prices will eventually lead to higher demand and lower supplies. The beneficial income effects of lower oil prices will show up in higher oil demand by oil importers including the United States, while the loss of revenues by oil exporters will act in the opposite direction. But the net effect on the global economy is likely to be positive.

He added that oil prices are likely to fluctuate within a wide range, the ceiling being the marginal cost for US shale oil producers (around $60 per barrel). For the Arab energy exporters, there will be a decline in economic activity, mainly because lower oil prices weaken domestic demand as well as external and fiscal balances. There are also negative growth effects for energy importers that have strong economic ties with oil exporters.

Former governor of OPEC Majid Al-Moneef laid out five factors that will determine the long-term oil market outlook: the technological advances and cost advantages of renewables, electric vehicles and smart mobility; the commitment to the Paris agreement on climate change; China as a leader in the emerging energy landscape; shifting trade patterns in oil and gas, and the geopolitics surrounding them; and the reviving role of the United States in global energy production.

He then outlined five potential factors determining the impact on Arab oil-exporting countries: their degree of dependence on oil to fuel economic growth; their adaptability to oil price swings or demand decline; their ability to form business, economic and political alliances; the effectiveness of new fiscal, energy, labour and industrial policies in response to the outlook; and the future role of the state and the private sector in the economy.

Policy responses

Several speakers explored potential policy responses by Arab oil-exporting countries. Allison Holland (International Monetary Fund) said that since the growth outlook remains subdued over the medium term, fiscal consolidation should continue to secure macroeconomic stability. At the same time, structural reforms need to be accelerated, including active labour market policies to support private sector job creation, enhancement of the business environment and the scope to exploit opportunities in global trade, and greater use of technology to improve access to finance

Magda Kandil (Central Bank of the United Arab Emirates) pointed out that pro-cyclical cuts in priority public spending threaten to undermine non-energy growth and diversification: there is a difficult balance between the pursuit of fiscal consolidation and growth. Beyond current macroeconomic policy though, there is a pressing need to adopt far-reaching structural and institutional reforms to move to a more competitive, knowledge-based economy, led by the private sector.

Hilde Bjornland (BI Norwegian Business School) also looked at the longer term, explaining that management of natural resource wealth should be seen as part of a strategy for sustainable, inclusive and broad-based growth. While the fiscal rule adopted in her native Norway has not managed fully to shelter the economy from oil price fluctuations, the goal of saving resource revenue for future usage has been accomplished. Her findings highlight the strengths and weaknesses of the fiscal framework adopted in resource-rich economies.

Hanan Morsy (European Bank for Reconstruction and Development) discussed the challenges of structural transformation. Diversifying away from oil is difficult, she noted, and it takes a long time. Success hinges on adopting appropriate policies ahead of the decline in oil revenues – and what worked for the few successful diversification cases (Indonesia, Malaysia and Mexico) may not work now.

Sovereign wealth funds

Another group of speakers focused on sovereign wealth funds. One study by ERF managing director Ibrahim Elbadawi and colleagues explored the potential role of these funds in supporting macroeconomic policy and helping to break the link between resources windfalls and government expenditures that exacerbates cycles of boom and bust.

Another study by Elbadawi and colleagues examined why cross-border investments by these funds within the Arab region are relatively low: the answer lies in the poor quality of economic governance institutions in potential recipient countries. With what is expected to be stiff competition for the resources of sovereign wealth funds under the ‘new global oil order’, capital-scarce Arab economies must significantly improve those institutions.

A new global order

Chairing the final policy panel, Mustapha Nabli (North Africa Bureau of Economic Studies and ERF) pulled together some of the threads running through the conference.

The world is changing in fundamental ways, he said, and that is not appreciated as much as it should be in the Arab region. In countries where there is consciousness of the new global order and when politics allows, there has been a first wave of relatively easy, technical reforms. But a next generation of reforms is needed that is much more fundamental: of institutions, governance, transparency, accountability and society at large.