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    (l-r) Kuwait’s Finance Minister Anas Al-Saleh and IMF’s Deputy Managing Director Min Zhu at the opening of the conference. Gulf states must diversify economies to sustain strong future growth (photo: IMF)

    (l-r) Kuwait’s Finance Minister Anas Al-Saleh and IMF’s Deputy Managing Director Min Zhu at the opening of the conference. Gulf states must diversify economies to sustain strong future growth (photo: IMF)

    GULF DEVELOPMENT CONFERENCE

    Gulf Economies Should Diversify to Sustain Strong Future Growth

    IMF Survey

    June 3, 2014

    • Oil-based growth model in the Gulf led to rapid development, but with cost
    • Diversification is needed to reduce reliance on oil, support growth and jobs
    • International experience shows education, competition, incentives are crucial

    Economic diversification is vital if the countries of the Gulf Cooperation Council (GCC)—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates—are to sustain strong growth in the future, a regional conference heard.

    The high-level conference on “Economic Development, Diversification, and the Role of the State” was held in Kuwait City during April 30-May 1 and co-hosted by the International Monetary Fund (IMF) and Kuwait’s Ministry of Finance.

    The forum brought together international experts, high-level policymakers from the region, and renowned academics to shed light on successful diversification strategies, drawing on international experience and that of some countries in the region. In the discussions, participants emphasized the importance of developing a non-oil tradable sector and a strong and competitive business environment to achieve sustainable growth.

    “The GCC countries have grown strongly and seen huge improvements in their development indicators, but they remain susceptible to fluctuations in oil markets and, hence, need greater economic diversification to help boost productivity and living standards, create jobs, and reduce the fiscal and external risks associated with the heavy reliance on oil revenues,” said IMF’s Deputy Managing Director Min Zhu in his opening remarks to the conference.

    Current growth model

    The prevailing growth model in the GCC has achieved a rapid improvement in human development indicators, but has also resulted in a decline in relative economic performance. The main features of this growth model are the reliance on oil as the main source of export and fiscal revenues, the dependence of the private sector on low-wage expatriate labor, and the concentration of economic activity in the low skilled non-tradable sector.

    The current model has not yet produced viable tradable sectors and diversified economies. A key challenge for the region is to generate jobs in the private sector for the rapidly growing young population. The question is whether GCC countries can continue to depend on oil revenues to support economic development in the long-term. The answer, according to conference participants, is “probably not.”

    “Kuwait's growth model has generated large improvements in living standards and welfare,” Kuwait’s Finance Minister Anas Al-Saleh told the conference, but he added that this growth model has involved many costs. “The public sector wage bill is currently very high as a percentage of public spending and subsidies are exhausting the state budget," Al-Saleh noted.

    Ongoing diversification is not enough

    Policies are already being implemented by GCC governments to diversify economies. For instance, with modern infrastructure including two major airports and a seaport among the largest in the world, an ample number of world-class hotels, and business-friendly environment, the case of the United Arab Emirates (UAE) always comes to mind as a successful diversification story in the region.

    Other countries in the region are implementing policies as well through the development of economic cities (Saudi Arabia), the targeting of development in specific industries (e.g. airline logistics in Qatar and aluminum in Bahrain), and promoting entrepreneurship through small and medium enterprises (Kuwait and Oman). These policies, however, would be more effective if the underlying economic incentives for the private sector were first changed, and discussions during the conference showed that much more still needs to be done.

    “Dubai has become a logistics and transportation hub, but there are no gains in productivity as the focus was on low-productivity sectors,” said Mohamed Lahouel, Chief Economist of Dubai Department of Economic Development. He noted that with a high share of nationals employed in the public sector, there is insufficient engagement of nationals in the private sector. “This distorts education and employment incentives,” Lahouel told the audience.

    Muhammad Al-Jasser, Minister of Economy and Planning in Saudi Arabia, pointed out that the GCC countries had made huge strides in economic and social development. He said that more diversification was now needed to support the next phase of growth, and told the conference that the role of the state should be as a growth facilitator rather than an employer of last resort. It should provide infrastructure, regulations, and incentives while ensuring that the heath care and education systems are improving and the skill sets of the population are developing.”

    Diversification to support growth

    Panelists examined the rationale for diversification. Some argued that diversification away from oil and other extractive industries would lead to higher long-term growth, more jobs for the young and growing populations, less dependence on returns from sovereign wealth funds, as well as better environmental conditions.

    Others pointed to empirical evidence that growth and diversification are positively correlated as diversified economies are less likely to experience economic volatility due to external or internal unfavorable economic conditions. Some conference participants also explained how a diversified economic base can secure stable revenues for the government to spend on public services, including infrastructure, while reducing poverty and generating equitable growth.

    Changing the incentive structure

    The distribution of oil revenues has important effects on the incentive structure in the GCC economies, the conference heard. For employees, the relatively higher wages and benefits available in the public sector make it often a more attractive employment choice, particularly for lower-skilled workers, compared to the private sector. For firms, producing goods and services to meet the consumption and investment needs of the domestic market, while relying on low-wage foreign labor, is more profitable than attempting to enter riskier and more competitive export markets.

    Conference participants stressed the need to ensure that economic incentives in the GCC encourage people to work in the private sector and firms to seek new export opportunities. The standard policy advice—implementing structural reforms, improving institutions and the business environment, investing in infrastructure, and reducing regulations—is very important, but may not be sufficient to spur tradable production unless the incentive structure changes, panelists noted.

    Education is paramount

    Improving the quality of education to ensure that workers have the skills needed to thrive in the private sector was a key theme throughout the discussions. Speakers highlighted problems with educational quality in the region, including high illiteracy rates in some cases, poor performance in math and science, and “diplomatitis”—a phenomenon by which students study only to earn diplomas and social status, not to acquire knowledge that can be used in private sector employment.

    Panelists stressed the role of education and science in the successful diversification experiences of many countries, including Korea and Malaysia. Overall, speakers put much emphasis on the need to correct the current mismatches between education curricula in the GCC and the MENA region at large and skills needed by the private sector, including through better vocational training to strengthen technical skills.

    Philippe Aghion, Professor of Economics at Harvard University, emphasized the role of education in enhancing productivity growth. “Productivity growth is fostered by better school performance, which hinges on a combination of teacher quality and efficient tutorship, and good synergy between central and local levels,” he said.

    Competition helps diversification

    Conference participants also put emphasis on the need to encourage competition and entrepreneurship as important elements of a successful diversification strategy.

    The Korean, Indonesian, Malaysian, and Singaporean diversification experiences suggest that a focus on competition in international markets and technological upgrades to climb the value added ladder are crucial. The Malaysian competitiveness was preserved, for example, by horizontal shifts from primary sectors to manufacturing, vertical shifts from upstream (raw materials) to downstream (rubber, oil, and gas) industries, macroeconomic stability in the form of low inflation, and productivity growth that exceeded wage growth.

    Conference participants acknowledged, however, that diversifying oil-exporting economies is a difficult challenge, particularly in countries where the remaining oil resource horizon is long. Evidence suggests it takes decades before full diversification takes hold.



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