Few petroleum economies have as far-reaching economic diversification plans as the GCC. In their quest for post-oil growth, the Gulf monarchies bring many assets with them, including mature bureaucracies, good infrastructure, and solid public goods provision. They outperform most other non-OECD hydrocarbon producers in all these categories. Nonetheless, the GCC faces some economic diversification challenges that are unique to the region and are not always well understood by policymakers or their advisors.
Most notably, the unusually generous unique social contract that GCC citizens enjoy creates cost structures for private producers as well as disincentives on the private labor market, making traditional industrialisation strategies difficult to implement. For overcoming these constraints, there is no clear blueprint or precedent. Diversification will instead necessitate cautious experimentation and a gradual reformulation of the social contract to reduce distortions while maintaining GCC nationals’ living standards.
More about the Cost of Production…
GCC governments have been relatively successful in spreading middle-class wealth among national populations that were, for the most part, desperately poor just two generations ago. However, the distribution of wealth through channels such as generous state employment has resulted in relatively high costs for local producers: Operating a business in the GCC, like in other high-income countries, is not cheap, especially when firms are under pressure to hire nationals whose wage and working-hour expectations are informed by the generous government packages.
The GCC economies have advantages that other late industrialisers do not have: low capital costs, high penetration of consumer technology, well-managed state-owned enterprises in critical sectors, and a geostrategic location between Europe, Asia, and Africa. Some economists see access to relatively cheap foreign labor as an additional advantage, but long-term evidence suggests that reliance on such labor has pushed GCC economies into a low productivity path, in contrast to other industrialisers, where growing supply constraints on domestic labor pushed firms to invest in skills and technology. GCC economies, for the most part, continue to be organized around foreign labor – cheap enough to maintain an efficient service economy for residents but not low enough to compete with truly low-cost producers in Asia.
In the majority of GCC countries, there is still time to redefine the social contract: except for Bahrain and Oman, they have enough fiscal runway to smooth the transition to a new system. However, given current oil prices, this will not be the case for much longer, particularly in Saudi Arabia, which is relatively poor. Sticking to the current welfare system for too long raises the risk of a forced adjustment in which the social contract is forcibly dismantled due to fiscal and currency crises, as Egypt has recently experienced.
