photo: L.C. Nøttaasen
The Saudi Arabian economy has been jolted by a severe oil shock. Crude oil that sold for over $100 per barrel in 2014 sold for only $26 per barrel in February 2016. The price rose to $50 by June 2016, but it remains half of what it was two years ago. As an extremely specialized exporter of oil, Saudi Arabia is particularly vulnerable to a price decline. Oil revenue paid for 73% of the government’s budget in 2015. As oil revenue fell, the budget deficit increased from 3.4% of GDP in 2014 to 16.3% in 2015. Foreign exchange reserves dropped by $116 billion in 2015.
The government sector dominates the Saudi economy. More than 70% of the workforce is employed by the government. Saudi Arabia had the “world’s third largest military budget, trailing only the U.S. and China and ahead of Russia” (Yergin). The government has heavily subsidized energy and food. Current levels of government spending and taxation are not sustainable, even with substantial borrowing.
The size of the necessary adjustment to the oil shock depends on how low the oil price will be and how long it will remain low. If the price of oil jumped back to $100 by the end of 2016, only minor economic adjustments would be necessary. However, if the inflation adjusted oil price remained at or below $50 per barrel for the next 25 years, a major transformation of Saudi economic policy would be necessary. In addition to the currently low price of oil, there is also the possibility of a major technological change that would permanently reduce the demand for oil and other fossil fuels.
Persistence of Oil Shocks
Forecasts of future oil prices have been notoriously inaccurate (Baumeister and Kilian), however recent decades have produced periods of persistently depressed oil prices. Saudi Arabia suffered from the sharp and prolonged price decline that began in 1980 and persisted for nearly a quarter of a century. From 1980 to 1986 the real oil price in 2015 dollars dropped from $100 per barrel to $30. The price remained low for years, and it did not rise above $40 until 2004. The “oil glut” had a devastating effect on economies of Saudi Arabia and other oil exporters. Saudi real GDP per capita dropped from $54,500 in 1980 to $31,000 in 1987. This oil shock also harmed other oil exporters, and the period coincided with the disintegration of the Soviet Union. If real oil prices in the next quarter of a century turn out to be similar to what they were during the post-1980 decline, major changes in Saudi Arabia will be unavoidable.
New King and New Government
By coincidence, about the same time oil prices reached their recent low point, King Abdullah bin Abdulaziz died in January 2015. He was succeeded by the new King, Salman bin Abdulaziz, who appointed officials who appear to be committed to major economic changes in the Kingdom. Crown Prince Mohammed bin Salman, the 30- year old son of the King, has considerable authority over economic and foreign policy. Khalid al-Falih, the new oil minister, replaced 80- year old, Ali al-Naimi, who had been in power since the 1980 oil crisis. The new Foreign Minister, Adel Al-Jubeir has observed that Saudi Arabia has already experienced large changes in the last generation, including large improvements in infant mortality, literacy, and women’s educational achievement (Al-Jubeir). However, the simultaneous oil shock and government change provide an unusual opportunity to implement major changes in future Saudi economic policy. This period could be a historical critical juncture that results in fundamental economic reform, but there is also strong resistance to change from powerful incumbents.
Economic Crisis and Economic Reform
The new government, led by Prince Mohammed bin Salman, has proposed major economic changes called Vision 2030. The current low oil price is the immediate reason for change, but Prince Mohammed has said that the proposal is intended to deal with long-term economic reform (Wall Street Journal 2016d) regardless of the oil price. A basic goal is to reduce the importance of oil to the Saudi economy. Various government subsidies would be reduced, including electricity, fuel, and water. Some retail prices were already raised in 2015. The potential labor force is unusually young, with more than half under the age of 25. They will be seeking employment outside the oil sector. Currently more than 70% of the work force is employed by the government, and the proposal would reduce government employment and make compensation less generous. About 30% of the current work force consists of immigrants who are not citizens, and the proposal would give Saudi citizens preferential treatment over migrants for employment. This kind of employment discrimination could harm economic reform, if more productive immigrants are replaced by less productive citizens, who are often accused of “indolence” (Economist 2016b).
To meet the immediate revenue shortfall, more government borrowing is proposed. The government would issue more bonds, and it would also sell 5% of the national oil company, Aramco. Shares in the company would become publicly traded on some major stock exchange, and investment bankers have already expressed enthusiasm in participating in the initial public offering (IPO) of shares. To sell Aramco shares on public exchanges, Aramco would have to become much more transparent about its revenue, costs, and other aspects of management relevant to prospective shareholders. Interestingly, Aramco was a private company before it was nationalized four decades ago.
The long-run goal of the reform proposal is to reduce the relative importance of oil to the Saudi economy. Specifying what sectors would expand is not so easy. The plan proposes increases in revenue from tourism, although there is a serious current problem with Iranian tourists. Problems with Iraqi Shiites and other Muslim sects considered to be deviants are also barriers to additional tourism. The proposal advocates greater production of non-oil minerals and more processing of raw materials. Additional production from sectors other than oil would require an increase in the currently low labor force participation rate of women, but this would be difficult to do without increasing the rights of women. Another barrier to new economic activities is the extremely low spending on research and development relative to GDP. Arab countries spending on R&D is far below the average for OECD Countries, and Saudi Arabia has one of the lowest R&D spending ratios among Arab countries. (Economist 2016b). Critics have pointed out that top-down proposals to reform economies have rarely succeeded in the past. Nearby Dubai has successfully diversified its economy toward services, but it is considerably smaller and different from Saudi Arabia.
Problem: Diminished Influence in World Oil Market
Saudi Arabia has less influence over the world oil market today than they once had, and the new oil minister and Prince Mohammed appear to be aware of their diminished influence. The Saudi share of world oil reserves fell from 25% in 1990 to 15.7% in 2014. Ali Al Naimi, who was recently replaced as oil minister, also acknowledged the diminished influence of his country over the world oil market. He has publicly stated that he made a mistake in 1980 by attempting to raise the world oil price by decreasing Saudi production. It was not successful, and as a result, the Saudis were harmed by both a lower quantity sold and a lower price. This time al Naimi vowed to continue a high level of production, and his replacement recently publicly committed to the same policy of producing enough to protect the Saudis market share (Yergin, Greenstone et al, Baumeister and Kilian).
As a result of the shale revolution, the US has substantially increased its oil production (Grennes and Strazds). Additions to oil production from the US are one reason why prices have fallen so much. US production has decreased since the price decline, but US shale producers are considered to be more flexible and more responsive to price (Wall Street Journal 2016f). They are smaller firms, and they are expected to increase production more quickly than traditional larger firms if prices rise (Yergin).
Since sanctions against its exports were reduced, Iran has again become a major exporter of crude oil. Some problems related to insurance on oil tankers has been overcome and Iranian exports are now near their pre-embargo levels. As a result of added competition, Saudi Arabia has recently given discounts on oil sold in Europe (Wall Street Journal 2016c). The rivalry between the Saudis and Iran has also made it more difficult to agree on collective production goals for OPEC members.
Problem: High Cost Agricultural Subsidies
When Saudi income was higher, the government provided many subsidies, including costly subsidies for domestic food production. One of the costliest was the subsidy to wheat production, which was rationalized as contributing to food security (Bloomberg). Subsidies made the desert bloom, and the nation went from being totally dependent on wheat imports to becoming self-sufficient in wheat and becoming a minor exporter of wheat. Saudi wheat production reached its peak in 1992 when it produced 4.1 million tons, and was briefly one of the world’s ten largest exporters. The country can no longer afford the costly program, and (World-Grain.com) by 2016 nearly all the wheat consumed in Saudi Arabia is expected to be imported (World-Grain.com). A large part of the subsidy came from using water obtained from a costly desalinization process. According to one estimate, water that cost the equivalent of $100 to produce was sold to wheat farmers for $1. (Grennes and Goodwin). In the name of food security, the government has also bought costly agricultural land in foreign countries, especially in Africa. It remains to be seen whether food produced abroad on land owned by Saudis would be cheaper or more secure than importing food from the lowest cost source. Presumably food exports would be subject to the export controls of African governments. Why would African officials allow food exports in the presence of famine in their own countries? A Saudi agency has also bought a share of the Canadian Wheat Board along with US grain company, Bunge (Globe and Mail).
Problem: Mixing Economics, Politics, and Religion
Separation of religion and state is a sensitive issue in countries with large Muslim populations. The Ottoman Empire had a caliphate that combined religion and state. Ataturk produced a revolution that separated religion from the secular state of Turkey, but supporters of Erdogan are currently trying to produce a counterrevolution that would reunite religion and government. When the Ottoman Empire disintegrated, the new state of Saudi Arabia was formed through an alliance between the clan of Ibn Saud and the Wahhab branch of Sunni Muslims. This alliance continues to make it difficult to separate religion and government, and it influences both domestic and foreign economic policy. Wahhabis advocate an austere branch of Sunni Islam that considers religion and the state to be inseparable, and they are strongly opposed to Shiites and branches of Sunni Islam that are considered to be deviants.
The new government’s proposal to increase the labor force participation of women is opposed by Wahhabi leaders. They also oppose women’s right to drive automobiles, which would increase job opportunities for women. The proposal to increase revenue from tourism, is harmed by the conflict between Shiites and Sunnis that has resulted in the cancellation of pilgrimages to Mecca this year by Iranian Shiite Muslims. Many store owners oppose a government proposal to close shops at 9pm. Many customers prefer later hours that allow them to avoid the extreme heat of earlier hours. Some shop owners have threatened to move to Dubai or some other location with a more favorable business climate. The powers of the religious police (Commission for the Promotion of Virtue and Prevention of Vice) have been curtailed recently, but some prominent clerics have spoken in favor of expanding their authority (Wall Street Journal, Conservatives Balk at Saudi changes, 2016d.) Although most Saudis are Sunni Muslims, there is a Shiite population especially, in Eastern Province where most oil is produced, and they claim to be victims of religious discrimination. The alliance between the royal family and Wahhabis is complex, and some extreme Wahhabi leaders have criticized the government for selling out to the West.
Foreign policy is heavily influenced by the rivalry between Sunni Saudi Arabia and Shiite Iran. The bitter rivalry has spilled over to other countries in the region, including Iraq, Syria, Lebanon, and Yemen. The result is a Saudi military budget that is one of the largest in the world. Saudi Wahhabis have supported madrasas in Pakistan and Kosovo that have produced many volunteer soldiers for Islamic State (News and Observer). Saudi Arabia, itself, has been the second largest source of military volunteers to Islamic State. Saudi Arabia has produced terrorists, including 15 of the 19 who attacked New York and Washington in 2001. It also produced Osama bin Laden. In recognition of some prominent terrorists with Saudi connections, the US Senate passed a bill May 17 that would allow families of Sept 11 victims to sue the Saudi government (News and Observer). The reduced importance of oil imports for the United States has increased uncertainty about the nature of the traditional alliance between Saudi Arabia and the US.
There are conflicts between proposed economic reform and conservative Islam in Saudi Arabia. However, the barriers are not insurmountable. In neighboring Qatar, Wahhabism coexists with a much more modern economy (Economist 2016a). The emir, Tamim bin Hamad al Thani, is sympathetic toward western economies, and even conservative women drive in Qatar.
Cheaper oil is a major shock to the Saudi economy. However, the simultaneous occurrence of the oil shock and a new government provides an unusual opportunity for fundamental economic reform. Barriers to reform include the presence of powerful interest groups that benefit from subsidies, the continued appeal to seek food security at high cost, and the objection of Wahhabi leaders to many aspects of modern economies. Uncertainty about the future political/military relationship with the United States makes it difficult to reduce the large military budget.
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