IMF Survey : Oil Price Drop Highlights Need for Diversity in Gulf Economies
IMF News, December 23, 2014
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Bibliographic details
- Published: December 23, 2014
Overview and context
- Publication date: December 23, 2014
- Key context: "With oil prices declining by 40 percent since June, the importance of diversification is once again highlighted."
- Focus: The need for Gulf Cooperation Council (GCC) countries to adjust incentives for workers and firms to promote non-oil tradable-sector activity and reduce reliance on oil revenues.
Assessment of the current GCC growth model
- The GCC growth model relies on oil as the main source of export and fiscal revenues.
- Achievements cited:
- Increased public sector employment.
- Increased spending on infrastructure, health, and education.
- Raised standards of living.
- Support for private sector activity in construction, trade and retail, transport, and restaurants.
- Weaknesses cited:
- Exposure to volatility in the global oil market.
- Limited private sector job creation relative to long-term needs.
- Need to establish a non-oil economy for a future with diminished oil revenues.
- Distortive effects of oil revenues noted:
- Appreciation of the real exchange rate (Dutch disease) can reduce competitiveness of other sectors.
- Oil revenues can corrode governance and institutions and induce economic volatility.
Lessons from international case studies
- Historical note: Few examples of successful diversification while oil production horizons remain long.
- Countries examined as examples: Malaysia, Indonesia, Mexico; Chile (diversification away from copper).
- Common themes from successful cases:
- Diversification took a long time and often accelerated only when resource revenues began to dwindle (example: Malaysia’s export-oriented strategy began in the early 1970s, with rapid growth in export sophistication in the 1980s–90s; "It took more than 20 years to reach a level of sophistication comparable to some advanced economies.").
- Successful countries implemented incentives for firms to develop export markets and for workers to acquire relevant skills and education.
- Policies and actions used:
- Investing in high-productivity industrial clusters, even absent prior comparative advantage.
- Developing horizontal and vertical linkages from industrial clusters (examples: Malaysia — downstream/upstream activities around rubber and palm oil; Mexico — linkages around the automobile sector).
- Using foreign capital to promote technological transfer via free trade zones, tax incentives, and easing tariff and non-tariff barriers (example: Indonesia in the 1980s; Mexico’s accession to NAFTA attracting FDI).
- Using export subsidies, tax incentives, and access to finance to facilitate entrepreneurial risk-taking, especially for small and medium-sized enterprises; support by development banks, venture capital funds, and export promotion agencies.
- Investing in training to ensure availability of high-skilled workers (examples: Malaysia and Mexico focused on training, skill-upgrade, and sponsoring workers for foreign training).
Findings on why GCC diversification efforts have been limited
- Policies to date focused on:
- Securing a stable economic environment.
- Improving the business climate.
- Investing in infrastructure and education.
- These steps have yielded some GDP diversification but have not sufficiently addressed the distortive effect of oil revenue distribution on incentives.
- Specific distortions:
- High wages and generous benefits encourage nationals to seek public sector employment over private sector jobs.
- High government spending in a relatively protected domestic environment encourages production of non-tradable goods and services.
- Exports remain "mostly oil" despite some progress.
Policy recommendations and measures to spur diversification
- Realign incentives for firms and workers to promote non-oil tradable activity:
- Move away from using the public sector "as the employer of first and last resort."
- Ensure education and training systems provide skills needed for private sector employment.
- Develop stronger social safety nets to guarantee minimum income levels and support job search activities.
- Firm-side measures:
- Address lack of competition in some domestic markets.
- Reduce incentives for low-productivity production.
- Encourage firms to pursue export opportunities and look beyond domestic markets.
International Monetary Fund