Draft 09 the Secret of Dubai's Long-Run Economic Success Counter Intuition

Saturday, April 08, 2023 DRAFT 09

The Secret of Dubai’s Long-Run Economic Success:

COUNTERINTUITION

Ohan S. Balian, Ph.D.

Dubai


June 2009

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To my mother

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Acknowledgments

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Preface

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Table of Contents

Acknowledgments...................................................................................3Preface.....................................................................................................4Introduction.............................................................................................6Counterintuition and Super-Competitiveness.......................................16

Dutch Disease...................................................................................16Super-Competitiveness and Productivity..........................................22

Capital Inflows and Investment............................................................34Real Estate........................................................................................34Tourism.............................................................................................44Finance..............................................................................................54

Economic Policy vs. Commercial Policy..............................................59Economic Policy Effectiveness.........................................................59Commercial Policy and Market Structure.........................................67

Governance and First-Best Solutions....................................................73Governance Indicators......................................................................73The ‘Luxury’ of Choosing First-Best Solutions...............................80

Dubai Strategic Plan (2015) and Sustainability....................................84Building-Blocks of DSP (2015)........................................................84The Rising Cost-of-Living................................................................90Some Labor Issues............................................................................95

Bibliography.........................................................................................99

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IntroductionA ski resort in the desert, a ‘palm tree’ on the sea, a hotel under

the sea, the tallest building in the world, and the list goes on and on, all

examples of counterintuition defined as intuition that is counter to

common expectations. When Stephen Hawking, a world renowned

physicist disabled by a crippling disease was asked why he was so fa-

mous even in the eyes of the general public, he replied: “People simply

did not expect to see me on a wheelchair”. But to achieve these coun-

terintuitive outcomes, one has to be super-competitive because these

achievements must be beyond expectations.

This book reveals the secret of Dubai’s remarkable economic

success by showing that its governance structure, institutional setting,

market structure, and economic policies have all been highly supportive

of powerful market forces, beyond the control of any government,

which have channeled investments into the most profitable sectors. Al-

though the emirate of Dubai, one of the seven emirates of the United

Arab Emirates (UAE), does not contain much oil, it has experienced

large inflows of capital. The book is written in simple non-technical

language and is not an exposition of the latest theories and practices in

public policy making. It also does not contain extensive descriptive

data on the performance of the Dubai economy which can be easily

found in hundreds of newspaper articles and from the recently launched

portal of the Dubai Statistics Center (www.dsc.gov.ae). The book sim-

ply places what Dubai has achieved so far in the ‘right’ perspective in

the sense that all of its actions and policies are based on fundamental

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http://www.dsc.gov.ae/


economic principles. It also argues that counterintuitive ideas, in both

industry and government, are key to the economic success of Dubai

with scarce natural resources and a small native population. Although

there is a huge literature on the competitive advantage of nations in the

form of resource abundance, low labor costs, and good governance,

very little has been said on the ability of nations to create this competi-

tive advantage; what is termed as super-competitiveness in the form of

achieving improvements in the many factors that affect overall eco-

nomic performance.

The secret of Dubai’s economic success has been the govern-

ment’s ability to recognize and identify the flow of resources into spe-

cific sectors and devise original and innovative policies to take maxi-

mum advantage of these flows. Perhaps one of the best examples of a

counterintuitive outcome is the so-called Dutch Disease. When Nether-

lands in the early 1970’s discovered natural gas, the common expecta-

tion was that the resulting export earnings would lead to rapid eco-

nomic growth. But contrary to this expectation, Netherlands experi-

enced high rates of unemployment and inflation. The explanation of

this counterintuitive outcome was that large inflows of capital, which

are unrelated to the productive capacity of the economy, caused an in-

crease in wages. As wages (a cost) began to increase, producers in-

creased their prices (a revenue) to maintain their pre-existing levels of

profit. Producers in the non-tradable sector (services such as banking,

tourism, and real estate) were able to increase prices but they could not

do so in the tradable sector (mainly manufacturing) because prices of

manufactured goods are determined in international markets. Since

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profits in the non-tradable service sector were greater than profits in the

tradable manufacturing sector, resources (both labor and capital) began

moving from the tradable manufacturing sector to the non-tradable ser-

vice sector. This process of Dutch Disease, also known as de-industri-

alization, caused unemployment - because labor was moving out of the

manufacturing sector and it takes time to train these workers to work in

the non-tradable service sector - and inflation - because the prices of

non-tradable services increased.

A similar process has been happening in Dubai with one major

difference – no unemployment. As capital inflows in Dubai have in-

creased, the returns on resources (labor and capital) have increased in

the non-tradable service sector which is evidenced by the booming real

estate and tourism sectors. There has been no surge in unemployment

because Dubai has started from a relatively low manufacturing base

and all the labor and capital that has moved into the non-tradable ser-

vice sector is new and did not come from the tradable manufacturing

sector. This phenomenon is reflected in higher prices in the real estate

sector, and many other non-tradable services, as evidenced by the rising

cost-of-living in Dubai. The secret of Dubai’s economic success is its

ability to reinforce the flow of resources into the non-tradable service

sector such as real estate, tourism, and financial services. Most Dubai

government policies, initiatives, and investments can be traced to the

higher returns in these non-tradable service sectors, the biggest sector

being the real estate sector.

But just as capital inflows have increased the profitability of

non-tradable sectors such as real estate and banking, the current global

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financial crisis has considerably reduced capital inflows into Dubai, in

turn lowering the profitability of these sectors as reflected in falling

property and stock prices. The more interesting question is where has

all the money gone? The answer is that it is ‘trapped’ in banks because

of their unwillingness to lend at current low rates of interest; and,

‘trapped’ with the public because of their unwillingness to invest since

they expect property and stock prices to fall further. This situation,

known as a ‘liquidity trap’, has severe policy implications since the rate

of interest is so low that no one is willing to lend and everyone is hold-

ing money in idle balances earning very low interest. In such a situa-

tion, even if the government injects liquidity into the financial system,

banks are not willing to lend because of very low interest rates. In other

words, the traditional policy prescription of using an expansionary

monetary policy to increase the availability of loanable funds does not

work in a ‘liquidity trap’ situation. A more effective solution to escape

this trap is for the government to bypass banks and, among other ac-

tions, lend directly to the public. This direct policy intervention is cur-

rently being adopted by the US government. For this reason, the recent

liquidity injection of about $30 billion by the UAE Central Bank may

not immediately ease the credit shortage faced by consumers if banks

are not somehow ‘forced’ to lend at low interest rates, and if the gov-

ernment does not find alternative channels of lending directly to con-

sumers. The ultimate cost of a ‘liquidity trap’ is that weak banks will

fail unless they merge with stronger banks because weak banks will not

be able to make profits at low interest rates.

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To be counterintuitive, one has to be highly competitive and

productive. ‘Normal’ competitiveness will enable one to achieve nor-

mal outcomes. To achieve outcomes counter to common expectations,

one has to be super-competitive which is defined as being productive in

the ‘other’ factors that affect economic growth. To better understand

this definition, when economic commentators speak of productivity

they do not specify the productivity of which input. Usually, productiv-

ity implies labor productivity – or output per-man hour – and higher la-

bor productivity generates higher rates of growth. But there are many

‘other’ factors which affect economic growth such as physical capital

(machinery and equipment), human capital (education), knowledge

transfer (especially the embedded technology in imported goods), insti-

tutions, and much more. A more accurate description of the productiv-

ity of an economy would be total factor productivity which takes into

account the ‘mix’, with labor, of all these ‘other’ factors which affect

economic growth. In other words, how much a worker produces de-

pends on how much capital he or she has, on his level of education, on

his health, on the available technology, on institutions, on governance,

and on much more – what Robert Solow appropriately called a measure

of our ignorance. Super-competitiveness, in addition to the normal

competitive factors, takes into account these ‘other’ factors to improve

our measure of ignorance. The secret of Dubai’s economic success, to a

large extent, is explained by the strengthening of these ‘other’ factors

through strong leadership, improved governance, knowledge transfer,

and much more, and in the achievement of successful, yet counterintu-

itive outcomes.

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Economic success also depends on the effectiveness of eco-

nomic policies. However, in most emerging economies, there is some

misunderstanding of economic policy as developed countries know it.

When economists talk about economic policy, they usually mean fiscal,

monetary, trade, and labor policies at the country level which are con-

ducted through changes in taxes, the money supply, import tariffs, and

the like. In most emerging economies, economic policy is regarded

more as ‘commercial’ policy which can be conducted through rules and

regulations. This interpretation of economic policy is especially blurred

in the United Arab Emirates primarily because each emirate can formu-

late its own rules and regulations at the emirate level. Economic policy

deals with macroeconomic issues such as unemployment, inflation,

budget and trade deficits, and is not directly concerned with influencing

market structures. The indirect effects on industry are more of a by-

product of these policies. Commercial policy, on the other hand, affects

market structure directly through rules and regulations on free zones,

establishment of enterprises, and competitive practices which are nor-

mally enacted by local specialized government agencies. One of

Dubai’s biggest successes has been the recognition of this difference

between economic policy and commercial policy in the design of poli-

cies to attract foreign investment and increase domestic competition.

The secret of Dubai’s economic success is its ability to achieve

a more accurate measure of our ignorance through the use of indicators

for improvements in government performance – the ‘other’ super-com-

petitive factors which affect overall economic performance. As Albert

Einstein famously noted, “Not everything that can be counted counts,

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and not everything that counts can be counted”, Dubai has been highly

successful in choosing indicators that measure government perfor-

mance more accurately. These indicators have sometimes been adopted

by looking at best practices in other countries, especially in the emerg-

ing economies of Asia, and have been modified to capture the specific

characteristics of local government agencies. Dubai has also been suc-

cessful in avoiding the ‘moral hazard’ problem - a situation in which

firms and institutions perceive that the government will bail them out if

they fail or under-perform - by rewarding successful enterprises and de-

moting unsuccessful ones through its various excellence programs.

Dubai has also been able to achieve remarkable economic suc-

cess because of its governance structure which has enabled the choice

of first-best or optimum solutions to pressing problems. In most devel-

oped countries, policy decisions and the enactment of laws and regula-

tions require considerable time and debate prior to implementation. Al-

though these policies are usually based on intuitive research and policy

debates, the relationship between policy research and policy making in

the real world is very weak. Several studies have shown that the rela-

tionship between policy analysis and policy making is not very strong

because of the influence of special interest groups, and because of dif-

ferences in the objectives of policy researchers and policy makers.

These differences have been very often responsible for choosing sec-

ond-best solutions to urgent economic problems in developed countries.

This is another example of a counterintuitive outcome in the sense that

although common sense tells us to base our decisions on ‘scientific’ re-

search for optimum outcomes, there are so many complexities in the

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real world that we cannot measure policy variables accurately, espe-

cially those ‘other’ factors of a productive economy which explain a

sizable portion of overall economic productivity. For this reason, ini-

tially counterintuitive policies may yield first-best optimum outcomes.

To sustain this rapid economic growth, the Dubai government

in 2005 began to formulate a 10 year strategic plan known as the Dubai

Strategic Plan DSP(2015). Although the DSP(2015) covered economic,

social, infrastructure, and security issues, the economic development

component was based on 6 building blocks to generate an annual aver-

age rate of growth of 11% with the help of 880,000 additional workers

over this 10 year period. DSP(2015) contains hundreds of action plans

and initiatives which are currently being implemented by the govern-

ment. Unlike standard 5 or 10 year development plans formulated by

many developing countries, the DSP(2015) is a ‘live’ document taking

into account changing regional and global economic conditions. The

DSP(2015) also makes sure that its recommendations and many initia-

tives are based on fundamental economic principles tested in developed

economies, and has been modified to take into account the specificities

of the Dubai economy such as market structure, immigration, labor is-

sues, and the expected rise in the cost-of-living.

The rising cost-of-living in Dubai is an expected outcome be-

cause it is caused by the high rate of government spending (as it builds

the infrastructure of a rapidly growing economy), and a high rate of

capital inflows (as it attracts foreign direct investment). The increase in

the general level of prices is also fuelled by the increase in the prices of

non-tradable services as the demand for such services has increased due

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to Dutch Disease effects noted earlier. The rising cost-of-living is also

due to the fixed-exchange rate regime with the US currency which has

fallen considerably in recent years causing an increase in the relative

price of Dubai imports, especially imports from euro zone countries.

This has been reflected in the high price of intermediate inputs such as

cement and steel which are heavily used in the real estate sector. But

the recent increase in the value of the US dollar has somewhat reduced

inflationary pressures, and the slowdown in capital inflows caused by

the global financial crisis has also lowered prices of non-tradables as

evidenced by the decline in property and stock prices. However, re-

gardless of the underlying causes of inflation in Dubai, the government

has not been able to adopt ‘standard’ economic policy tools, such as in-

creasing the rate of interest or decreasing the money supply, because its

fixed exchange rate regime with the US dollar has tied the movement

of its domestic interest rate with movements in the US rate. Moreover,

even if Dubai desires to control its rate of inflation through contrac-

tionary monetary policies, it has few degrees of freedom because the

money supply is controlled by the UAE Central Bank at the federal

level. Alternatively, the Dubai government has adopted counterintuitive

policies in controlling inflation using various price and rent controls.

The rising cost-of-living has also eroded the purchasing power

of unskilled workers. Although it is becoming increasingly more diffi-

cult to retain skilled workers due to the rising cost-of-living in Dubai,

nominal wages of skilled workers have actually increased due to Dutch

Disease effects. There is no doubt that wages of unskilled workers have

eroded in recent years but that is primarily due to the fall in the US dol-

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lar. This erosion of purchasing power has been somewhat rectified due

to the recent appreciation of the US dollar. Moreover, both the Dubai

local government and the UAE federal government have achieved con-

siderable progress in improving labor conditions of unskilled workers,

much more than the improvements achieved by the governments of

their home countries. This book illustrates the many examples in which

Dubai has adopted counterintuitive policies to generate rapid rates of

growth. But the adoption of counterintuitive policies requires super-

competitiveness to identify and measure the ‘other’ factors that affect

overall productivity such as leadership, innovation, technological

change, and institutional performance. The secret of Dubai’s economic

success has been its ability to identify, in Einstein’s words, ‘what

counts’, and formulate appropriate policies, very often counterintuitive,

to achieve first-best optimum outcomes.

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Counterintuition and Super-Competitiveness

Dutch Disease

Perhaps the best example of a counterintuitive outcome is the

so-called Dutch Disease or de-industrialization caused by a large in-

flow of capital which is unrelated to the domestic productive capacity

of the economy. Although the original model by Corden and Neary

(1982) looks at the effects of a natural resource discovery (natural gas),

they were well aware that the same effects could be generated by large

capital inflows caused by Foreign Direct Investment (FDI), remit-

tances, foreign aid, or the discovery of precious metals such as gold.

Corden and Neary group the goods and services produced by an econ-

omy into three groups: natural resources (oil), tradable goods (manu-

facturing), and non-tradable goods (services)1. By definition, tradable

goods are subject to international competition; hence, their prices are

determined by international demand and supply, and it is assumed that

the country is small enough so as not to be able to influence these

prices. Services, since they are non-tradable, are not subject to interna-

tional competition and therefore their prices are determined by domes-

tic demand and supply2.

1 The building & construction sector is also regarded as a non-tradable sector because you cannot physically ‘import’ or ‘export’ a building. Perhaps the earliest example of this awareness was when foreigners in the early 70’s were purchasing buildings in the UAE and residents became very worried and complained to His Highness Sheikh Za-yed Al Nahyan, the late President and founding father of the UAE. His wise reply was that as long as they were not tying ropes around buildings and pulling them to their home countries, he was not really worried. 2 Tradable sectors are defined as sectors that produce goods for both domestic con-sumption and exports (imports). Non-tradables are sectors that produce goods and

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The Dutch Disease model distinguishes between a resource

movement effect and a spending effect. A rise in the price of oil in-

creases the demand for labor and capital in the oil sector which leads to

higher wages and a higher return on capital in that sector. If factors are

mobile and can move between different sectors, then this will induce

labor and capital to move from the manufacturing and services sectors,

to the oil sector. Output and employment in the oil sector will thus in-

crease while output and employment in manufacturing and services will

decline. While the price of manufactured goods does not change (be-

cause it is determined internationally), the decline in services output

leads to excess demand for services and therefore to an increase in the

price of services3. Resources (both labor and capital) would move into

the production of services to meet the excess demand. This is known as

the resource movement effect. The spending effect occurs when some

fraction of the increase in income generated by the booming oil sector

is spent on both the tradable and non-tradable sectors. This higher in-

come would push-up the price of non-tradables. But since prices of

tradables are fixed (since they are determined in international markets),

then an excess demand for tradables can only be eliminated by an in-

crease in imports. At the same time, the price of services relative to the

price of manufactured goods also increases causing an appreciation of

the real exchange rate – i.e. a unit of foreign currency now buys fewer

services only for domestic consumption. 3 It is explicitly assumed that the market for non-tradable goods (domestically pro-duced) always clears through the price system – i.e. an excess demand causes domes-tic prices to increase and an excess supply causes domestic prices to decrease. In the tradable sector, excess demand and excess supply are eliminated through increases in imports and exports respectively.

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goods in the domestic economy as it did before. This real appreciation

weakens the competitiveness of a country’s manufacturing exports, and

causes de-industrialization. Both of these changes take place because of

the spending effect.4

Combining the spending and resource movement effects, the

Dutch Disease hypothesis generates four predictions. First, since the

relative price of services increases, the real exchange rate appreciates.

Second, there is an unambiguous decline in manufacturing output and

employment. Third, the combined effects on output and employment in

the oil sector and the service sector are ambiguous because the spend-

ing and resource movement effects pull in opposite directions. How-

ever, if the oil sector employs relatively few workers or if labor mobil-

ity is low, then it is expected that the spending effect will dominate the

resource movement effect in which case we would also expect to see an

increase in service sector output and employment. Fourth, if labor is

mobile, then the overall economy-wide wage level will increase.5

4 Appreciation of the real exchange rate will occur regardless of whether the nominal exchange rate is fixed or flexible. Under a fixed nominal exchange rate, such as in the UAE and in all the GCC countries except in Kuwait, the conversion of the foreign currency into local currency would increase the country’s money supply, and pressure from domestic demand would push up domestic prices. This is why under a fixed ex-change rate system this real appreciation will lead to higher inflation, the case in most GCC countries. This would amount to an appreciation of the real exchange rate be-cause a unit of a foreign currency now buys fewer ‘real’ goods and services in the do -mestic economy than it did before. If the exchange rate is flexible, the increased sup-ply of foreign currency would drive up the value of the domestic currency which also implies an appreciation of the real exchange rate, in this case through a rise in the nominal exchange rate rather in domestic prices. In both cases, real exchange rate ap-preciation weakens the competitiveness of the country’s manufactured exports and causes deindustrialization. 5 For an excellent discussion of Dutch Disease and its practical applications to the real world, see Migara, K. and O. De Silva (1994).

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The above analysis is more relevant for resource rich countries

with an abundance of oil or other natural resources. For an emirate such

as Dubai with scarce endowments of natural resources and a small na-

tive population, the source of Dutch Disease has been the large inflow

of Foreign Direct Investment (FDI)6 caused by the creation of a busi-

ness friendly environment, especially after 2001. We thus look at FDI,

as opposed to oil revenues, as the major source of capital inflows

which, again, is not related to the internal productive capacity of the

Dubai economy. This approach leaves us with two sectors: a tradable

manufacturing sector and a non-tradable service sector. The increase in

FDI causes similarly an appreciation of the real exchange rate which re-

duces the competitiveness of the tradable manufacturing sector and

leads to deindustrialization7. As the return on capital and wages begin

to increase because of the spending effect, resources begin to move

from the tradable manufacturing sector into the non-tradable service

sector since producers in the tradable sector cannot increase their prices

because prices of manufactured goods are set internationally especially

in a small open economy such as Dubai which is a price taker and can-

not influence world prices. This resource movement effect in Dubai has

been evidenced by the dramatic growth of the real estate, tourism, and

financial sectors. Moreover, since Dubai has started from a low indus-

trial manufacturing base, most of the labor and capital in the non-trad-

6 A survey conducted by the Dubai Statistics Center in 2007 showed that FDI was $11.6 billion in 2006, or an increase of 13.4% compared to 2005. 7 One explanation for why deindustrialization is perceived to be ‘bad’ is because there is more scope for technological progress in manufacturing than in services except in information technology and financial services, areas in which Dubai has achieved substantial progress.

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able service sector is coming from abroad as evidenced by the increase

in the expatriate population. The Dubai government, recognizing this

phenomenon, has formulated appropriate policies to reinforce these re-

source movement effects into the highly profitable service sectors such

as tourism, finance, and real estate.

The recent global financial crisis has considerably reduced capi-

tal inflows into Dubai with ‘reverse’ Dutch Disease effects. In other

words, as the inflow of capital has slowed down, the upward pressure

on wages has somewhat subsided. This slower rate of growth of the

wage rate has caused a reversal of resource movements out of the non-

tradable service sector as evidenced by layoffs in the real estate and fi-

nancial sectors in recent months. Profitability, especially in the real es-

tate sector, has also been reduced to ‘normal’ levels with lower expec-

tations. This is a good sign since property prices were getting out of

control and it was becoming increasingly difficult to attract and retain

skilled workers. The slowdown in the rate of growth of wages has also

been helpful in controlling inflation caused by the increase in aggregate

demand through the spending effect. As capital inflows have decreased

due to the global financial crisis, these reverse Dutch Disease effects

have been very helpful to slow the rate of growth of the economy, espe-

cially in non-tradable service sectors. This lower spending by con-

sumers has been to some extent offset by increased government spend-

ing as Dubai builds its modern infrastructure.

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Super-Competitiveness and Productivity

The competitiveness of a country is a highly ambiguous concept

since it incorporates many variables and indicators on the performance

of the economy. Strictly speaking, there are two meanings of competi-

tiveness: ‘business’ competitiveness as elaborated in various competi-

tiveness reports, and ‘economic’ competitiveness which depends on

factor endowments and productivity. Business competitiveness is best

illustrated by the annual reports published by the World Economic Fo-

rum (WEF) and the International Institute for Management Develop-

ment (IMD)8. Neither IMD’s nor WEF’s rankings are comparable

through time due to changes in data, methodology, and countries cov-

ered. IMD’s World Competitiveness Index (WCI) has continued in the

spirit of the original indices and has been mostly moderate in its revi-

sions, and its methodology was considerably revised in 2001. WEF in-

troduced a completely new measure, the Current Competitiveness Index

(CCI), and relabeled the World Competitiveness Index (WCI) as the

Growth Competitiveness Index (GCI).9

8 WEF is an independent non-profit organization based in Geneva, Switzerland. It promotes economic growth and social progress worldwide and has NGO consultative status with the United Nation’s Economic and Social Council. Its activities are funded by multinational corporations. IMD is an independent non-profit foundation and a premier business education institution located in Lausanne, Switzerland. It educates business executives at every stage of their careers. 9 WCI measures and compares how countries are doing in providing firms with an en-vironment that sustains the domestic and global competitiveness of the firms operat-ing within their borders. Similarly, CCI evaluates the underlying conditions defining the current level of productivity. GCI is considerably different from the two and it aims to measure the capacity of the national economy to achieve sustained economic growth over the medium term, controlling for the current level of economic develop-ment.

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There is no readily available economic theory that could be ap-

plied to the construction of these indices. Growth literature provides

some guidance in selecting the appropriate variables and their relative

weights but, beyond that, index crafters must rely on expert judgments

and ad hoc empirical analysis10. All the indices combine ‘hard’ data

(statistical indicators such as wage rates, inflation rates, interest rates,

etc) and ‘soft’ data (indicators based on survey responses such as inten-

sity of research collaboration, implementation of new technology, ease

of doing business, etc)11. According to both IMD and WEF, current

competitiveness is the same as having an attractive environment for a

firm’s business activities. This is somewhat different from typical defi-

nitions of competitiveness which emphasizes a country’s ability to offer

a high and rising standard of living to its citizens or the ability of a na-

tion state to continuously attract high value-added activities in such a

way that all factors of production are employed and earn high returns.

Economic competitiveness, on the other hand, looks at resource

endowments and how these resources are used most efficiently in the

production process at both the micro and macro levels. Some countries

are competitive in the production of certain products simply because

they are abundantly endowed with natural resources. For example,

Saudi Arabia is economically competitive in the production of oil sim-

10 Porter’s (1990) work on competitiveness has influenced WCI and his diamond model is highly visible in CCI. GCI is influenced by Barro (1991) and subsequent works. 11 The indices have several shortcomings, the most serious critique relating to the Ex-ecutive Opinion Surveys, namely, that opinions of fewer than 20 business managers do not provide solid foundations for economic analysis.

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ply because its vast oil deposits are very cost effective to extract. Eco-

nomic competitiveness at the macro level has to do with the economy-

wide production function which is a technical relationship between out-

put (GDP) and the various inputs that go into the production of that

output. The functional relationship between total output and the various

inputs is always positive but the degree of the effect on output depends

on factor intensities and on the ‘mix’ of the different inputs. At the mi-

cro level, economic competitiveness has to do with market structures at

the industry level such as perfect competition, monopoly, duopoly, or

monopolistic competition. Countries usually have little control over

economy-wide competitiveness in the short-run, but can affect market

structures through various competition rules and regulations.

Nonetheless, competitiveness, whether ‘business’ or ‘eco-

nomic’, is important because it lowers costs and forces the factors of

production to be more productive – that is, the same unit of input pro-

duces more output than before. But when economic commentators talk

about productivity, they normally do not specify the productivity of

which input. The common measure of productivity, at least in the US,

is labor productivity – output per man-hour. But the productivity of an

economy depends on much more than the productivity of its labor12. It

also depends on the ‘mix’ or efficiency with which the ‘other’ inputs in

the production process are combined with labor – what is known as To-

tal Factor Productivity (TFP)13. In other words, the amount of output

that a unit of labor can produce depends on the amount of capital that

12 Productivity is important because it affects per capita GDP which in turn deter-mines the rate of growth of the economy. 13 Also known as Multi Factor Productivity (MFP).

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the worker has, on his level of education, on his health, on his training,

on institutions, on governance, and so on – what Robert Solow called a

measure of our ignorance14. In effect, we are saying that an increase in

TFP means that more output is obtained without increasing the quantity

of inputs. This distinction between labor productivity and TFP is im-

portant because labor productivity might be increasing not because

workers are working harder, but simply because they have more capital

to work with. Since this capital is costly, it will ultimately reduce over-

all economic productivity. The same argument can also be made for all

the ‘other’ inputs that affect overall economic productivity such as hu-

man capital, technology transfer, institutions, and so on. The important

point for policy purposes is that overall economic productivity will be

overstated if the measure is labor productivity because we are not tak-

ing into account the costs of capital, education, healthcare, technology,

institutions, and so on15. TFP takes into account these costs and will

therefore exhibit lower rates of overall productivity growth.

Intuition tells us that interest rates will be low during periods of

economic slowdown as governments push down rates to generate eco-

nomic growth. The interest rate can be looked upon as the cost of capi-

tal since investors need to borrow to make investments. But given that

the economy is in a ‘liquidity trap’, banks are not willing to lend at low

levels of interest and will only be willing to do so at higher rates, thus

pushing up the cost of capital. In other words, although market rates are

14 This does not imply that we do not know what these ‘other’ inputs are. It simply means that they are difficult to measure. 15 For this reason, the Organization for Economic Cooperation and Development (OECD) looks at Total Factor Productivity especially for cross-country comparisons of productivity growth. See OECD (2001).

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very low, actual rates - rates at which banks would be willing to lend -

are much higher. This higher cost of capital will be reflected in lower

productivity growth which will eventually lead to slower economic

growth. The current economic reality in Dubai is very similar to this

situation which is evidenced by the fact that if one goes to the bank to

borrow money, banks are only willing to lend at about 7-8%, even to

their high net-worth customers. Again, a highly counterintuitive out-

come in the sense that higher investment will lead to lower productivity

growth, in turn, leading to lower economic growth.

These ‘other’ inputs that affect productivity growth can be

grouped under three main headings: knowledge; factor supplies; and in-

stitutions16. By knowledge we mean the creation, transmission, and ab-

sorption of knowledge. Since knowledge cannot be directly measured,

it is often proxied by R&D and by the number of patents. There is very

strong evidence to suggest that increases in knowledge positively affect

productivity growth, and increases in the stock of knowledge are

caused by investments in education and R&D. Knowledge can also be

imported in the form of FDI (where technologically advanced foreign

firms invest in the domestic economy) and/or in the form of technically

advanced imported products (such as computers, advanced machinery,

high-tech equipment, etc). Generally, more open economies tend to be

better positioned to import knowledge from abroad although the effec-

tiveness of this advanced knowledge may be limited by the absorptive

capacity of the economy. For example, an educated and healthy popula-

tion will be in a better position to absorb and learn from imported

16 For a comprehensive literature survey of these ‘other’ inputs, their determinants, and effects, see Isaksson (2007).

26


knowledge. The creation of knowledge through innovations has also

been shown to be an important determinant of productivity growth

where innovation can be defined as a network of institutions (universi-

ties, public and private research centers and think-tanks), rules, and

procedures that influence the way by which a country acquires, creates,

disseminates, and uses knowledge.

Factor supplies mean the supply of human capital17 (healthcare

and education), infrastructure, and the supply of savings (financial sys-

tem). A better educated and healthier workforce is much better posi-

tioned to absorb and use the latest techniques in both the manufacturing

and service sectors, the latter in the form of better managerial tech-

niques and processes. A good infrastructure reduces transaction costs of

doing business as the transportation of both goods and people becomes

more efficient, and an efficient financial system allocates savings to in-

vestments in such a way that returns on capital are maximized. With

respect to institutions, there are generally 3 main issues that policy

makers need to consider to increase productivity: enforcement of prop-

erty rights (encourages investment); constraints on the actions of pow-

erful groups (reduces the risk of expropriation); and equal opportunity

for all (ensures equitable distribution of income). Better and stronger

institutions result in higher savings and investment which in turn cause

faster productivity growth rates. Institutions are also important in im-

17 It is implicitly assumed that capital (machinery, plant and equipment) can be mea-sured and is always used by labor. For this reason, it is not usually included in the ‘other’ factors which influence productivity growth.

27


proving the process of innovation because it is regarded as a public

good and cannot be left to the market alone18.

The term institution can be interpreted either as a political entity

or an economic one. In the former context, institution means the system

of political structure such as democracy or autocracy. As an economic

entity, institution implies the rule of law and property rights. There is

very strong evidence that institutions play an important role in generat-

ing higher rates of productivity growth19. But the more interesting ques-

tion is whether there are certain institutions that secure, for example,

property rights better than others, and hence, generate faster productiv-

ity and growth rates. In a democracy, factors of production are allo-

cated according to market forces given that citizens are well informed

and that the state establishes a sound set of laws, rules, and rights20. But

for these rules and rights to be effective, the state must be highly com-

mitted which is not always possible in an autocratic system because cit-

izens cannot force autocrats to do so. But this does not mean that

democracy works better than autocracy because threats to property

rights in a democracy can originate from powerful groups such as orga-

nized labor or special interest groups. An ideal political system would

be “a system where the state is effective in what it does while being in-

sulated from what it does not want to do”. (Rodrik 1992).

18 Innovations cannot be totally left to markets because the market outcome might be sub-optimal. 19 See Acemoglu, D. (2003). 20 Are citizens really well informed? Do they have access to accurate sources of infor-mation? These are highly restrictive assumptions, and once dropped, the whole con-cept of ‘the market’ as an efficient allocator of resources becomes ambiguous.

28


The secret of Dubai’s economic success can be explained by its

ability to be super-competitive by focusing on these ‘other’ factors

which affect total factor productivity21. In terms of the creation, absorp-

tion, and transmission of knowledge, Dubai has been creating various

‘knowledge centers’ such as Dubai Knowledge Village, Dubai Aca-

demic City, Dubai Internet City, and Dubai Silicon Oasis. Dubai

Knowledge Village (DKV), launched in 2003, places the Middle East

on the map as a destination for learning excellence and provides a

ready environment for a variety of knowledge-based entities including

training centres and learning support entities. This thriving knowledge

community was founded as part of a long-term economic strategy to

develop the region’s talent pool and accelerate its move into a knowl-

edge-based economy. Benefits for DKV partners include 100% foreign

ownership, 100% freedom from taxes, 100% repatriation of assets and

profits, and effortless visa issuance procedures. DKV also offers first-

rate facilities for the use of its knowledge partners and their students in-

cluding serene landscapes, food courts, and sports grounds. Its partners

include diverse nationalities such as Australians, Indians, Pakistanis,

Iranians, Russians, Belgians, English and Irish. DKV has over 350 part-

ners which include training centres, professional centres and HR com-

panies. DKV also enjoys the distinction of being the world’s only free

zone totally focused on professional training and learning support ser-

vices.

21 This may be one explanation for the relatively low levels of productivity figures in Dubai because these ‘other’ factors which affect total productivity are costly and re-duce overall economic efficiency in the short-run.

29


Dubai Academic City (DAC) is the world’s only free zone dedi-

cated to higher education. A regional base for premier international

higher educational institutions, DAC is the world’s first dedicated ter-

tiary cluster development. Spread across an area of 25 million square

feet, the DAC campus provides an intellectually inspiring environment

for students and faculty. Benefits for DAC partners include 100% for-

eign ownership, 100% tax free, and 100% repatriation of profits. There

are currently 32 international universities of higher learning from di-

verse regions including USA, Australia, India, Pakistan, Iran, Russia,

Belgium, UK, and France, operating out of DAC and catering to the

needs of over 12,000 students. These include Michigan State Univer-

sity, The University of Wollongong in Dubai, Middlesex University

Dubai, and S.P Jain Centre of Management Dubai, among many others.

These institutions offer programs that range in duration from one year

to four years. Major academic programs on offer include engineering,

computer science, media studies, environmental studies, child develop-

ment, quality management, and business management programs.

Dubai Internet City (DIC) provides a strategic and cost effective

platform for ICT companies targeting emerging markets in a vast re-

gion extending from the Middle East to the Indian subcontinent, and

from Africa to Central Asia. Launched in the year 2000, DIC now fea-

tures a dynamic international community of ICT companies including

global giants like Microsoft, Cisco Systems, IBM, HP, Dell, Siemens,

Sun Microsystems, Computer Associates, PeopleSoft and Sony Erics-

son. Many small and medium businesses and promising entrepreneurial

ventures are also part of the community. The cluster comprises compa-

30


nies from a variety of sectors - software development, business ser-

vices, web based and e-Commerce, consultancy, sales and marketing,

and back offices. DIC provides an environment that attracts all the ele-

ments of the ICT value chain, and has developed several programs that

can be leveraged by the community to explore and expand development

opportunities. Companies are privy to an advanced Ethernet broadband

infrastructure and a range of business-enabling services including gov-

ernment transactions. DIC also has the world’s largest commercial IP

telephony network and offers both 100% tax exemption and 100%

business ownership.

Dubai Silicon Oasis (DSO) was established by the Government

of Dubai in 2005 with the objective of developing an integrated

technology park highlighting industries built around the production of

information and communications technologies using semiconductors.

Its vision is to make DSO one of the world’s leading centers of

advanced electronic innovation design and development, and to create a

universally recognized state-of-the-art ‘technology oasis’ by facilitating

and promoting technology-based industries, research and development

within a fully integrated community. It is spread over a 7.2 square

kilometer area providing a highly conducive environment for

manufacturing companies, warehousing, and regional offices. It is

rapidly becoming a thriving urban community with a core technology

zone surrounded by a master-planned residential environment

consisting of villas, technologically advanced commercial and

residential buildings, and offering 100% foreign ownership, zero

31


personal taxation, zero corporate taxation, and a state-of-the-art IT

infrastructure.

Dubai has benefited immensely from its openness by acquiring

knowledge through its imported intermediate and final goods and ser-

vices, especially modern managerial techniques and construction tech-

nology. Dubai is also paying very close attention to upgrade its health-

care and education systems by establishing Healthcare City and con-

ducting a comprehensive reform of its education system to be more

compatible with the needs and requirements of a knowledge-based

economy. The Dubai Health Authority (DHA) was created in 2007 with

a clear mandate to upgrade health standards and improve the health of

everyone living and working in Dubai. Since then, DHA has been re-

sponsible for promoting international accreditation of all healthcare ser-

vices, and has actively promoted numerous partnerships between public

and private healthcare providers. The Knowledge and Human Devel-

opment Authority (KHDA), established in 2006, has the task of devel-

oping all knowledge and human resource sectors in the emirate of

Dubai. KHDA aims to develop the education and human resource sec-

tors and bring them on par with international standards and prevalent

best practices while keeping in mind the requirements of the job mar-

ket. Keeping in line with the economic and social growth in Dubai, the

KHDA was established to ensure the continuous development of the

education sector and to improve the quality and outcomes of education

on all fronts and at all stages22. Moreover, huge infrastructure projects

22 The first ever official study into local education conducted by the Dubai School In-spection Bureau found that 9 out of ten schools in Dubai were found to be providing education that was ‘acceptable’. See Annual Report 2009, Dubai School Inspection

32


from the Dubai Metro to the construction of new roads and bridges will

ultimately lead to reductions in transaction costs and increase total fac-

tor productivity. Dubai has also established a modern financial center

such as the Dubai International Financial Center (DIFC), encouraged

Islamic finance, and developed various financial markets which will ul-

timately maximize the returns on capital. But perhaps the biggest ad-

vantage that Dubai has over other emerging economies is its focus on

institutional performance23 by honoring property rights and a zero toler-

ance against corruption, especially in the booming real estate sector. In

the political dimension, Dubai’s governance is very close to the ‘ideal’,

as envisaged by Rodrik (1992) – “a system where the state is effective

in what it does while being insulated from what it does not want to do”

- a highly counterintuitive approach compared to most governance

structures in emerging economies.

Bureau. 23 Institutional performance is discussed in detail in the section on Governance Indica-tors.

33


Capital Inflows and Investment

Real Estate

The fastest growing sector in Dubai has undoubtedly been the

real estate sector where the booming domestic economy has caused a

large increase in the demand for both commercial and residential space.

The surge in tourism has also increased the demand for hotels, hotel

apartments, and various types of resorts to cater for the needs of differ-

ent types of tourists. Moreover, the expansion of existing industrial ar-

eas in duty free zones and the construction of new ones have substan-

tially increased the demand for housing for different income groups.

This dramatic growth in the real estate sector has posed three related

questions: What are the main causes of this growth? What are the un-

derlying economic fundamentals of the Dubai real estate market? And,

are there any signs of bubble trouble?

The current boom in real estate traces its roots back to 1997

with the creation of the publicly quoted Emaar and Nakheel properties

which have spawned developments such as Dubai Marina, Burj Dubai,

The Palm Jumeirah, The Palm Jebel Ali, The World, and The Uni-

verse24. Until 2002, only Gulf Cooperation Council (GCC) nationals

were allowed to hold property in Dubai while non-GCC expatriates liv-

ing in the UAE were only permitted to rent or own property on a feder-

ally approved 99-year leasehold basis. In 2002, the Dubai government

allowed the ownership of freehold property to all foreigners triggering

24 This list is by no means exhaustive. Many projects and developments are in the pipeline which will be completed during the 2008-2015 period, and beyond.

34


a chain of events which quickly began changing the face of the real es-

tate sector. The 2002 announcement coincided with another decree al-

lowing foreigners to purchase and own freehold property in selected ar-

eas of the city known as ‘New Dubai’. It then took until March 2006

for the publication of the new law legalizing foreign ownership of prop-

erties in designated areas. As a further move to boost investor confi-

dence in the real estate market, the Real Estate Regulatory Authority

(RERA) was established in July 2007. The main responsibility of

RERA is to formulate, regulate, and manage various real estate activi-

ties in Dubai. In 2009, RERA was affiliated with six global real estate

associations and organizations to improve property laws and protect the

rights of both developers and consumers according to global best prac-

tices.

The second major cause of the growth in the real estate sector is

the movement of resources into this sector because of its higher prof-

itability compared to the profitability in other sectors. As capital in-

flows into Dubai have increased, especially after 2001, the economy-

wide wage rate has also increased25. Producers, to make-up for the loss

in their profits, have been forced to increase their prices. They were

able to increase their prices in the non-tradable service sectors (the

most prominent being real estate) but they were not able to do so in the

tradable manufacturing sector because prices of manufactured goods

are determined in world markets. This difference between the higher

profitability in the real estate sector and the lower profitability in the

manufacturing sector has attracted developers into the real estate sector

25 Wages have increased because of greater spending caused by the increase in the money supply as a result of large capital inflows.

35


as evidenced by the increase in construction and related activities. The

Dubai government has been able to reinforce these resource movement

effects into the real estate sector by improving property laws and creat-

ing a highly conducive business environment for real estate developers.

At the same time, the Dubai government has not neglected the lagging

manufacturing sector which is evidenced by the establishment of vari-

ous industrial parks such as Dubai Investment Park and Dubai Indus-

trial City, to name just two.

Whenever the word ‘market’ comes across, one tends to think

of the concepts of ‘demand’, ‘supply’ and ‘price’. The real estate mar-

ket is no different in the determination of the ‘price’ of real estate

which is ultimately determined by economic fundamentals such as de-

mand and supply. However, the standard analysis of this market is

based on static instantaneous changes in market forces such as an

overnight increase in the supply of housing. But as we know very well,

an increase in the supply of housing does not happen instantaneously

and one needs time to build new houses, structures, and buildings.

Hence, in the real world, a more dynamic approach is required for real

estate price determination. A second caveat is that the simplistic view

of demand and supply is based on the assumption of perfect informa-

tion (for both buyers and sellers of property) and does not take into ac-

count speculative motives which more than often have driven property

prices, and which tend to be influenced by expectations rather than by

pure economic fundamentals. For these two reasons, the analysis of the

real estate market is not as straightforward as the analysis of other mar-

kets. For a more accurate determination of the price of real estate, and

36


for more effective policy intervention, one has to take into considera-

tion these shortcomings and be able to isolate the speculative factors

from pure demand and supply fundamentals.

Most economic commentators on the real estate market in

Dubai have attributed the increase in the price of property, housing, and

rents, to a supply shortage caused by the high rates of economic

growth. Some have argued that this surge will be eliminated as new

units are completed and released to the general public by 201026 thus

dampening the upward pressure on prices, while others have predicted

that the increase in population and tourism will result in further in-

creases in the demand for residential and commercial space and will

more than make-up for the increase in supply, thus sustaining the high

prices in the real estate market27. Another factor which has been putting

upward pressure on prices is explained by the actions of both individual

and institutional speculators who purchase and hold property for short

periods of time, and thus create an ‘artificial shortage’, eventually sell-

ing their properties at higher prices28.

Having realized this rapid pace of price increases in the real es-

tate market, the Dubai government has adopted various policies, with

varying degrees of success, to control this price increase. Perhaps the

most counterintuitive policy has been the use of rent controls for both

26 By some estimates, about 180,000 new units will be delivered by 500 registered de-velopers in 2010. However, due to the recent slowdown in the real estate market, only about 60% of these units are expected to be delivered on schedule. 27 The population of Dubai is expected to increase from 1.4 million in 2007 to 1.7 mil-lion in 2010, and tourism is planned to increase to 15 million by 2015. 28 This practice is commonly known as ‘flipping’. Some speculators also purchase property ‘off-plan’ (on the map) by paying 5-10% of its value and sell them at higher prices after a few months.

37


residential and commercial properties. The government in 2006 im-

posed a 15% cap on rental price increases which have been progres-

sively lowered to 7% in 2007, and most recently to 5% in 2008 for ten-

ants who have occupied their apartments for 2 years. This policy has

been counterintuitive since no country has been successful in holding

prices down using such controls29. The main argument against such

controls is that they discourage developers and divert investment to

more profitable sectors30. Rent controls also create black markets and

are difficult to administer since they need to be enforced on a case-by-

case basis and have many loopholes. Moreover, country experiences

have shown that once these controls are lifted, prices tend to overshoot

as landlords attempt to make-up for their ‘losses’. To control specula-

tion, the Dubai government has recently enacted new rules and regula-

tions administered by RERA to prevent property flipping by forcing

property buyers to hold their properties for relatively longer periods of

time, and by making it more difficult to purchase off-plan. Recent high-

profile corruption scandals by well known property developers have

also strengthened the government’s resolve against corruption by

declaring a zero tolerance policy. All of these policies have been de-

signed to maintain the traditionally high levels of confidence in the

Dubai real estate market.

As capital inflows into Dubai have decreased because of the

global financial crisis, the rate of growth of wages has also decreased.

29 Except Canada which also simultaneously controlled wages and incomes. 30 This is the reason for the transformation of the South Bronx area in New York City into a slum in the early 1970s as landlords began to cut down on maintenance, land-scaping, and other expenses.

38


However, profitability in the non-tradable sector, especially in real es-

tate, is still greater than profitability in tradable sectors such as in man-

ufacturing because producers in the manufacturing sector cannot in-

crease their prices to make-up for their ‘losses’ 31. Developers in the

real estate sector will still be able to raise their prices but not by as

much as before the decrease in capital inflows. Given this relatively

lower profitability in the real estate sector, investors will be inclined to

move their capital to more profitable sectors but since real estate invest-

ments entail ‘sunk-costs’, capital is not as mobile as one would ex-

pect32. Hence, the rate of return on capital will be lower as evidenced

by the fall in property prices in recent months. Some analysts have re-

cently predicted property prices to fall by as much as 80% in the com-

ing few months but such a large drop is highly unlikely because the

Dubai government has considerably increased its expenditure to trans-

form the Dubai economy from a supply-driven economy (where the

government builds a business friendly environment to attract producers

and suppliers of goods and services) into a demand-driven economy

(where economic activity will be determined by aggregate demand).

The real estate market has also been affected by lower spending as a re-

sult of reductions in capital inflows. This lower spending by consumers

and investors has pushed down property prices further to more ‘normal’

levels. This ‘reverse’ Dutch Disease effect has not been as powerful as

31 Producers in the manufacturing sector cannot increase their prices because prices of manufactured goods are set in international markets. This is why they are also known as ‘tradables’ – i.e. manufactured goods can be exported and imported. 32 ‘Sunk-costs’ are investments that cannot be easily relocated elsewhere because of the physical nature of the investments. In other words, once a building is built, the capital (cement, steel, etc) used-up in the process cannot be ‘taken-out’.

39


standard Dutch Disease effects demonstrated earlier because capital in

the real estate market is less mobile than in other sectors such as in the

financial service sector where one can easily withdraw capital. For this

reason, the adverse direct effects of reductions in capital inflows on the

real estate market will not be as severe as the adverse effects on bank-

ing, tourism, finance, and other non-tradable service sectors33.

Nevertheless, both the general public and various analysts are

deeply concerned about the effects of a real estate market ‘correction’.

So are there any signs of bubble trouble in the Dubai real estate mar-

ket? A simplistic view would be to say that if we can somehow separate

the increase in the price of real estate into its fundamental (demand and

supply) and speculative components, then if, say, 70% of the increase

in prices is caused by fundamentals and 30% is caused by speculation,

it automatically follows that the ‘correction’ would result in at least a

30% price fall. But just like a stock, a house has also a price-earning

ratio, where earning is interpreted as rent34. When we buy a stock (an

asset) we are effectively buying an earning stream. The price we pay

for the stock should reflect current earnings and reasonable expecta-

tions about future earnings. A bubble is created when these get discon-

nected. The price of a house follows a similar logic – namely, the price

paid for a house should reflect the present value of future rents that the

33 However, there may be indirect effects on the real estate sector because of liquidity shortages in the financial sector caused by ‘capital flight’. For example, as currency traders (primarily from GCC countries) were expecting a re-valuation of the UAE Dirham against the US dollar, they amassed large Dirham deposits at UAE banks. But as the de-pegging with the US dollar did not materialize, there was a huge ‘capital flight’ which reinforced the adverse effects of resource movements out of the real es-tate sector. 34 This section follows closely Leamer (2002).

40


buyer expects to receive. The buyer must ask how much the house

could currently be rented for on an annual basis, and then divide the

seller’s asking price by this rental number. That’s the price-rent ratio. If

a $200,000 house generates $10,000 rent annually, then the price-rent

ratio is 20. A high price-rent ratio can be justified if the house is in an

area that can be expected to experience high growth rates and thus

rapid appreciation in rents, just like a technology stock can have a

higher price-rent ratio than a car manufacturer. But one is completely

mistaken if he or she thinks that there can be a long-run disconnect be-

tween a house price and its potential rental stream. If such a disconnect

exists, then there is definitely bubble trouble.

Going back to the analogy with the price of a stock, when a cor-

poration experiences a rise in earnings, stockholders may bid up the

price of the stock by a percentage that is higher than the increase in

earnings, and thus increase the price-earning ratio. This new higher

price-earning ratio could be based on the idea that these higher earn-

ings are a permanent event. Similarly, if people think that there is a

‘momentum’ in rents with high appreciation supporting further in-

creases in rents caused by expectations of population growth, increased

tourism, and ‘shortages’, then the price-rent ratio of housing might also

be set at a higher level. In other words, this higher price-rent ratio is

based on the expectation of home buyers that rents will continue to rise,

thus justifying higher prices for houses. A lot depends on the validity of

these higher expectations which are in turn justified by so-called ‘short-

ages’ in housing. But a freely functioning market cannot have ‘short-

ages’. A market system has high prices for some goods and low prices

41


for others. A ‘shortage’ is created when the price mechanism is not al-

lowed to work. There can be a ‘shortage’ of umbrellas in a storm be-

cause sellers choose not to increase the price to equate supply and de-

mand. Then the sellers run out of umbrellas and people go without one

even though they would have been willing to pay a higher price. A

shortage can cause a rise in price if the fundamental demand and supply

conditions that caused the price increase in the first place persist, and if

the market is allowed to clear. But both the market for rentals and the

market for houses are highly evolved and do not suffer from the fixed

price pathologies that cause shortages. There are high rents, or low

rents, but no ‘shortages’. There is no ‘shortage’ of houses anymore than

there is a ‘shortage’ of cars, or diamonds, or shirts. Limitations on new

housing can cause rents to increase at an abnormally high rate for a pe-

riod of time but the higher rate of growth of rents should be quickly

‘capitalized’ in the price of a house once the market realizes the impact

of supply restrictions on future rents. That means a one-time jump in

price, and, thereafter, price changes like every other product – up some-

times, and down sometimes. In other words, since higher rents have

been capitalized in the price of houses, then there is no guarantee that

prices will always move higher.

The global financial crisis and the concomitant fall in Dubai

real estate prices have considerably reduced the willingness of banks to

lend, especially for housing loans. Some banks have recently doubled

the minimum salary requirement to qualify for a loan to consumers be-

low a certain threshold, putting extra pressure on consumers’ ability to

make timely mortgage payments. The recent fall in real estate prices

42


has also reduced the ‘perceived wealth’ of many homeowners in vari-

ous segments of the market. This wealth effect has reduced consumer

expenditure, one of the largest components of aggregate demand35,

putting added downward pressure on property prices. Property develop-

ers in Dubai have also announced ‘delays’ and some cancelations of

real estate projects which will reduce future supplies. The ‘net’ effect

on property prices will depend on the magnitude of these two market

forces. If the fall in demand caused by the unwillingness of banks to

lend is much larger than the fall in supply, then property prices will

surely fall. On the other hand, if the fall in demand is less than the fall

in supply, then the fall in prices will be moderate. Given that the UAE

Central Bank has injected more than $30 billion into the banking sys-

tem in recent months, and given that banks are currently more willing

to lend, albeit at more stringent terms and conditions, the fall in Dubai

property prices should not be very severe36.

35 Aggregate demand is the total demand for goods and services in the economy which is composed of 4 components: Consumer expenditure (C); Investment expendi-ture (I); Government expenditure (G); and net exports (exports – imports). In most de-veloped countries, consumer expenditure accounts for up to 80% of aggregate de-mand. 36 The ‘net’ effect is beyond the scope of this book. For a more rigorous analysis, one needs to identify and measure the many factors that determine both demand and sup-ply such as population growth, income, tastes, and many other factors.

43


Tourism

Another unexpected outcome has been the dramatic growth in

the tourism sector. This outcome has been unexpected because Dubai

had to compete with established tourist destinations in other parts of the

world, especially under the political instability of the Middle East.

Dubai has long been considered as the connecting link between Europe

and Asia with a long history of acting as the ‘middleman’ in the facili-

tation of trade. Oil does not play a major role in its economy (about 3%

of GDP) and tourism has contributed over 20% to its GDP attracting 6

million tourists in 2007 alone. The growth of the tourism sector can be

explained by the higher profitability in this non-tradable service sector

caused by Dutch Disease effects noted earlier. This higher profitability

has encouraged both public and private foreign investment in the devel-

opment of shopping malls, hotels, restaurants, entertainment and leisure

activities, and many other related services. The driving force behind the

development of the tourism sector has been the Department of Tourism

and Commerce Marketing (DTCM) with the specific objective of trans-

forming Dubai into a regional tourism hub.

The current global financial crisis will undoubtedly have an ad-

verse effect on the Dubai tourism sector. Tourism, by definition, is very

sensitive to changes in income. For a more accurate assessment of this

adverse effect, one has to distinguish between different types of tourism

such as ‘business’ and ‘leisure’ tourism. Over the last few years, Dubai

has been very successful in attracting a large number of ‘business’

tourists through its many international meetings, conventions, and exhi-

44


bitions. Whereas ‘leisure’ tourism is regarded as non-essential expendi-

ture and can be easily cancelled or postponed during economic hard-

ships, business type tourism is not as sensitive to economic downturns.

Unlike in most other emerging economies, the Dubai tourism sector is

highly diversified catering to the needs of different types of tourists. In

other words, the adverse effects of the financial crisis on the tourism

sector in Dubai will be less severe than in other cities because the fall

in tourism will be somewhat cushioned by the smaller fall in ‘business’

tourism due to the highly diversified nature of the Dubai tourism sector.

The indirect effect of the financial crisis on tourism is that as tourism

income falls, the profitability of this sector will also fall, forcing hospi-

tality ‘guest’ workers to move out of this sector. To the extent that

these ‘guest’ workers are willing and able to return back to their home

countries, there will not be a large pool of unemployed workers that the

government has to provide for through social and other programs.

Having realized the movement of resources into this non-trad-

able service sector, the Dubai government has initiated many projects

to reinforce these resource movement effects. The Dubai Shopping Fes-

tival (DSF) and the Dubai Summer Surprises (DSS) are only two no-

table examples in catering to the needs of international shoppers and

vacationing families. DSF was first started in February 1996 by the

Dubai government aimed at promoting trade in Dubai. Since then, it

has become an annual shopping, entertainment, and cultural extrava-

ganza that continues to promote tourism in Dubai and draws people

from around the world each year. On February 15, 1996, the travel in-

dustry in the Middle East heralded the beginning of a new dawn - the

45


birth of the most impressive shopping cum entertainment mega event.

An entirely new concept, it succeeded brilliantly in showcasing what

cooperation between private sector and public sector could do to create

a mind-boggling achievement. Initially, the DSF was conceived as a

pure retail event, the primary aim of which was to revitalize the retail

trade in Dubai. It was later developed into a comprehensive tourism

product in line with Dubai's far-sighted vision to set global standards in

every field. DSF is basically a shopper’s paradise. Although Dubai is

known around the world as such a paradise throughout the year, the red

carpet is really laid out during shopping festival month with over 2,300

participating retail outlets that offer everything imaginable from gold,

perfume, haute couture, cars, and electronics, to handicrafts and tex-

tiles. As months of preparations went into creating DSF, the shopping

festival matured into a major retailing cum entertainment extravaganza.

Today, one of the biggest beneficiaries of the event is the

tourism sector. Hotels, travel agents and tour operators contribute to the

selling of the event worldwide and run at peak levels of operation dur-

ing the event. Every year, DSF lives up to its promise of staging the

most exciting activities for the whole family inspired by the theme

“One World, One Family, One Festival”. As universal brotherhood,

happiness, excitement, joy and adventure became the signature trade-

marks of DSF, the Festival itself became a tribute to the inherent ambi-

tion and strength of the people of Dubai. Local and multinational

brands acknowledged their faith in the event, and brands like Visa,

Pepsi, and Emirates Airlines became partners to DSF's growth. Most

hotels and apartments also get involved offering special discounts and

46


offers during the period. Even the world famous Burj Al Arab is in-

cluded in the hotels. With all these special discounts available, many

would feel that would suffice. But Dubai goes quite a few steps further.

There are scores of raffles that offer very attractive prices, and Emirates

Airlines and most other airlines flying out of Dubai offer discounted

airfares and much needed excess baggage allowances during the festi-

val. There are other events as well including international fashion

shows, children's events, street-side performances, nightly fireworks,

film festivals, and many other cultural events that reflect the emirate's

cosmopolitan character. One of the biggest events of them all, the

Dubai World Cup, also takes place during the festival with a staggering

US$ 12 million purse that makes it the richest horse race in the world.

The Department of Tourism and Commerce Marketing (DTCM)

has also focused on the worldwide promotion of Dubai as an ideal

tourist destination and a thriving commercial and business centre, very

attractive for Dubai property investors. This has involved setting up

DTCM representative offices in many countries as well as participation

in numerous international tourism fairs. In addition, DTCM has

launched highly successful campaigns worldwide and has organised

tourism related exhibitions. Dubai is also developing its medical

tourism industry by establishing Healthcare City in partnership with

Harvard Medical School to create a ‘centre of excellence’ for clinical

and wellness services, and medical education and research aimed at

competing with low-cost healthcare providing countries in Asia, espe-

cially Singapore and Thailand. This is another example of super-com-

47


petitiveness because Dubai is successfully competing with countries

which have a well-established history of offering medical tourism37.

In the leisure and entertainment sector, Dubailand 38 is the

world’s most ambitious project catering to the needs of the entire fam-

ily. This unique 3 billion square feet development has been designed to

catapult Dubai onto the global map, reinforcing its ambition of emerg-

ing as an international hub of family tourism appealing to tourist seg-

ments across genders, age groups, world regions, and activity prefer-

ences. Dubailand is projected to attract millions of tourists annually

from around the world once fully operational. A number of Dubailand

projects are currently up and running including Al Sahara Resort,

Dubai Sports City, and Dubai Autodrome, with a host of other projects

currently in their final stages to be completed by 2010. The diverse

projects under Dubailand include theme parks, eco-tourism projects,

shopping malls, restaurants, and residential units. The project is esti-

mated at $85 billion with a total of 45 mega projects and expects

40,000 daily visitors which will significantly contribute towards attract-

ing 15 million tourists by 2015 as outlined in the Dubai Strategic Plan.

It will also have a minimum of 55 hotels within its geographical loca-

37 Thailand, which received 1.2 million medical tourists in 2006, has gained an inter-national reputation for offering the best of both worlds – inexpensive surgery com-bined with a 5 star beach holiday. Singapore, whose healthcare system has been ranked 6th in the world by the World Health Organization in 2006, consistently earns high marks in international surveys of medical tourists. It is aiming to attract one mil-lion foreign patients a year by 2012.38 For a detailed description of Dubailand and its many theme parks and projects, see www.dubailand.ae

48

http://www.dubailand.ae/


tion and projects a population of 2.5 million people which includes

workers, residents, and different types of tourists once it is fully opera-

tional.

Dubai's exciting new tourism destination started off as a huge

cultural entertainment center to cater to the need for a central meeting

point where different countries could showcase myriad cultures. Over

the years it has grown into a star attraction among UAE nationals,

resident expatriates from over 160 different countries, and visitors from

across the world. Today, this major crowd-puller has been transformed

into a unique international destination for tourism, entertainment,

leisure and culture. As a world-class tourism destination, Global

Village brings together diverse customs and cultures covering a broad

spectrum of activities including music, dance, art, handicrafts, theatre,

costumes, and cuisines of different countries. In addition to hosting the

colorful activities that are organised by countries from the different

continents of the world, Global Village also offers a range of top

quality facilities and services including restaurants, shuttle transport

services, and a huge parking area that can accommodate thousands of

vehicles.

Dubai has also developed numerous other touristic attractions

over a relatively short period of time. The Burj Al Arab hotel has be-

come an iconic symbol of Dubai. It is one of the region’s most famous

tourist landmarks, and as a hotel it has set new standards for excellence

in Arabian hospitality. The hotel, which was inaugurated in 1999, es-

tablished its presence with its futuristic and magnificent exterior. The

World, an archipelago of 300 man-made islands off the coast of Dubai,

49


has been created from sand dredged from the sea. The World is a land-

mark for future eco-tourism projects worldwide and is one of several

tourist and commerce related projects off the coast of Dubai which can

be seen from space. Dubai Marina, set to be the world’s largest man-

made marina, located close to the heart of ‘New Dubai’ and linked with

Jebel Ali Port, Dubai Internet City, and Dubai Media City. Mall of Ara-

bia, set to be the largest shopping mall in the world, will have a final

gross leasable area of 10 million square feet. Dubai Sports City, an en-

tire sports city currently under construction in the entertainment com-

plex of Dubailand, featuring apartment buildings as well as state-of-

the-art stadiums and facilities. Dubai Sports City will be the envy of

venues around the world. Its centre-piece, a 60,000 seat, multi-purpose

outdoor stadium, will play host to football, rugby, and athletic matches.

Business Bay, a central business district located in Downtown Dubai, is

designed primarily for international trade purposes and will have up-

wards of 230 buildings for both commercial and residential purposes.

Burj Dubai, opening in 2009, is a super-tall skyscraper set to be

the tallest building in the world. In a breathtaking design, which en-

compasses the makings of a small city in its interior, Burj Dubai will be

the centerpiece of Dubai’s new Dubaitown District. Palm Trilogy, con-

sisting of three man-made islands in the shape of palm trees, has been

created to help solve Dubai's beach shortage. Atlantis is a 1,539 room,

ocean-themed destination resort located at the centre of the crescent of

the man-made Palm Jumeirah in Dubai. This US$1.5 billion joint ven-

ture project was developed with the Dubai government and was opened

in September 2008. The resort utilizes a 46 hectare site with 17 hectares

50


of water park amusement, further marine and entertainment attractions

and a collection of some of the most renowned world-class chefs in-

cluding Nobu, Giorgio Locatelli, Santi Santamaria and Michel Rostang.

Atlantis offers an unprecedented entertainment centre, an impressive

collection of luxury boutiques and shops, and extensive meeting and

convention facilities. It is home to one of the largest open-air marine

habitats in the world with some 65,000 marine animals in lagoons, and

displays including The Lost Chambers, a maze of underwater corridors

and passageways providing a journey through ancient Atlantis.

Culture Village, situated on the Dubai creek, will offer a plat-

form where all the components of a higher lifestyle can take place, sat-

isfying the intellectual as well as the practical needs of residents and

visitors. Visual arts, performing arts, and literary facilities will contrib-

ute to the higher standard style of living. Culture Village proposes a

wide variety in styles and in content of art galleries, museums, theatres,

public exhibition spaces, fashion activities, institutes specializing in

different disciplines, gardens, and many other activities pertaining to

the promotion of the arts in society and in the community in general.

Restaurants and specialty stores will offer a mix that contributes to the

eclectic and creative mood of the location. Bawadi will be the world's

largest hospitality and entertainment development boasting from end-

to-end a spectrum of amusement centres, shopping malls, theatres,

restaurants, convention centres, and hotels. Occupants at any of

Bawadi’s 60,000 rooms in over 51 hotels will have their own incredible

experience to bring back home. From the fabulous Desert Gate Hotels

and Towers that mark the entrance and exit to Bawadi to the 6,500-

51


room centerpiece Asia-Asia hotel, an 1,800-seat theatre, family and ex-

treme sports parks, a themed shopping mall as well as a 20,000 seat

multipurpose arena, Bawadi may stay unrivalled by any other develop-

ment in the world for a long time. Bawadi will also be home to the

world’s largest shopping area, literally promising a shop-till-you-drop

experience, and providing over 40 million square feet of gross leasable

area for retail outlets. Featuring malls, boutique malls, street shopping

and an underground shopping area connecting all of Bawadi’s elements,

the stage is set for Dubai to roll-out the longest shopping boulevard in

the world.

Besides its retail attractions including the Middle East debut of

several global, high-profile brands such as Waitrose and Hamleys, The

Dubai Mall has varied lifestyle and leisure offerings including a

sprawling Gold Souk, an Olympic-sized Dubai Ice Rink, and the multi-

media-rich Fashion Catwalk atrium. The Dubai Aquarium & Discovery

Centre is already in the global spotlight having clinched the Guinness

World Record for the ‘World’s Largest Acrylic Panel.’ The Dubai Mall

will have a total of over 14,000 spaces for parking across three car

parks, with valet services and a car locator ticketing system. Sprawling

over 12 million square feet - equivalent in size to more than 50 soccer

pitches – with an internal floor area of 5.9 million square feet and a

gross leasable area of 3.77 million square feet, The Dubai Mall is the

flagship development of Emaar Malls Group, the shopping malls sub-

sidiary of global property developer Emaar Properties. When fully op-

erational, The Dubai Mall will have over 1,200 stores of which nearly

165 retailers – equaling 1.1 million square feet or 30% of the total gross

52


leasable area of the mall, are either new to the region or opening stand-

alone or flagship stores for the very first time in Dubai. The retail mix

includes two anchor department stores, Gallery Lafayette and Bloom-

ingdale’s (both opening their first stores in the Middle East), two hun-

dred and twenty gold and jewelry outlets, one hundred and sixty food

and beverage outlets including Dubai’s largest food court with 40 out-

lets, a super-supermarket, and an organic food mart.

A major challenge facing the tourism sector is the current slow-

down in the global economy, which would adversely affect the tourism

sector because of its income sensitivity. However, given the high rates

of growth in GCC countries and the difficulties associated with out-

bound travel to Europe and the US, especially after September 2001,

Dubai has been focusing on attracting high-income tourists from Arab

and GCC counties in both the leisure and business tourism sectors.

Dubai is the regional hub for meetings, incentives, conferences, and

events (MICE) with over 100 international exhibitions and countless

events held annually ranging from CityScape in real estate development

to GITEX in information technology. On the other hand, Dubai is fac-

ing growing strains in its hotel capacity and infrastructure, and is work-

ing round the clock to broaden the range of its tourist services and up-

grade its infrastructure to meet the shopping and travel needs of its visi-

tors. The ultimate objective is to position Dubai as a global travel in-

dustry hub which is evidenced by building the largest airport in the

world, a state-of-the-art Metro system, and various leisure and enter-

tainment projects to attract 15 million tourists by 2015.

53


Finance

Dubai has also reinforced the flow of capital into the financial

service sector through the establishment of ‘financial centers’ such as

the Dubai International Financial Center (DIFC). The future of these

centers as modern international financial centers will depend on main-

taining a strong and transparent regulatory framework, continuing inno-

vation, and making improvements in human capital, the business envi-

ronment, and market access. DIFC was established in 2004 to serve as

a gateway for the flow of capital to and from the region, and was

spurred by the sharp increase in economic activity and the subsequent

need for substantial financial intermediation.39 DIFC offers its partici-

pants a highly attractive investment environment such as 100% foreign

ownership, zero taxation, and no restrictions on profit repatriation. It is

regulated by the Dubai Financial Services Authority (DFSA), an inde-

pendent regulator staffed by an impressive list of international profes-

sionals with a regulatory mandate covering asset management, banking

and credit services, securities, collective investment funds, custody and

trust services, commodities futures trading, an international equities ex-

change, an international commodities derivatives exchange, insurance,

and Islamic finance. DIFC has registered over 320 companies, and the

Dubai International Financial Exchange (DIFX) located at DIFC and

regulated by DFSA, has a market capitalization of about $40 billion. It

provides a dollar-denominated trading platform for international issuers

to raise capital and debt through conventional and Islamic instruments.

39 See IMF (2008).

54


These financial centers have fostered a vibrant market for Is-

lamic financial products.40 DIFC has already established a strong pres-

ence in this market with about $16 billion listed in DIFX, and interna-

tional investors are flocking to Dubai’s first Sukuk issuances and initial

public offerings. Several Islamic finance learning centers have also

been launched in Dubai which offer a range of Islamic financial, bank-

ing, and training programs to help meet the significant demand for hu-

man capital development. These learning centers are also aiming to at-

tract practitioners from countries with large Moslem populations such

as the US, UK, Germany, and France. The rapid pace of economic

growth is also boosting the demand for insurance products with Dubai

commanding approximately 50% of the UAE share. Life insurance is

also increasing while the non-life segment of the market such as acci-

dent and liability insurance accounted for 60% of total premiums col-

lected, followed by the fire, marine, and aviation segments. The bank-

ing sector in Dubai is also positioning itself to become ‘the’ regional

banking hub driven by the very strong performance of the sector in re-

cent years. There are currently 52 local and foreign banks in Dubai and

the sector is seriously considering consolidating given the turmoil in

global financial markets.41 This would considerably strengthen the abil-

ity of the banking sector to face global challenges by pooling resources

40 Islamic finance refers to a system that is consistent with Fiqh al-Muamalat (Islamic rules on monetary transactions). For example, since ‘interest’ is prohibited under Is-lamic law, instead of giving the borrower a loan, the bank purchases the item and re-sells it to the consumer at a mark-up. For an excellent discussion of Islamic finance, see Rahali (2008). 41 In 2007, Emirates Bank and National Bank of Dubai merged into a single entity, Emirates NBD. Such consolidations will ultimately create a few large banks with greater ability to withstand any external shocks caused by future crises.

55


and sharing risks. There is also very high potential in the retail banking

sector with strong consumer spending and negative real interest rates.

Dubai has also announced plans to establish a Financial Arbitration

Center to quickly resolve disputes between businesses and different

types of financial institutions.

In its assessment of financial service sectors, the IMF and the

World Bank jointly conducted a Financial System Stability Assessment

(FSSA) in the summer of 2007 and concluded that the banking sector,

which dominates financial intermediation, has enabled rapid credit ex-

pansion to households, corporations, and public and semi-public enter-

prises. Major construction projects for hotels, apartments, commercial

and entertainment properties, and infrastructure have dominated the

landscape in Dubai. Demand for credit has also been driven by rapid

population growth and interest rates in the domestic currency that are

negative in real terms. The assessment also demonstrated that the bank-

ing sector, as a whole, showed comfortable levels of profit having ben-

efitted from the rapid expansion of the economy. In this favorable envi-

ronment, the authorities have begun to open-up the banking sector to

greater competition, and several stress tests conducted by the IMF and

the World Bank joint team revealed that the banking system would

adapt very well to a variety of shocks. Specifically, banks have ab-

sorbed the recent decline in stock prices with little effect on their bal-

ance sheets, and the rapid increase in overall lending has helped offset a

drop in fees and commissions. The FSSA also concluded that the au-

thorities have made good progress in strengthening financial supervi-

sion by the approval of several key laws and the issuing of a new Code

56


of Corporate Governance (May 2007) that is expected to enhance the

governance and disclosure practices of listed financial companies.

Nevertheless, the current global financial crisis has created a sit-

uation in which people do not expect high returns on physical and fi-

nancial investments, preferring to keep their assets in short-term ‘safe’

bank deposits rather than make long-term investments – a ‘liquidity

trap’ situation. In such a situation, banks are unwilling to lend at these

low interest rates and consequently, any increase in liquidity by the

Central Bank is ‘trapped’ with unwilling lenders. The current situation

in global financial markets, and to some extent in Dubai, can be de-

scribed as a ‘liquidity trap’ situation42 in which the nominal interest rate

is so low that no one is willing to lend at the market rate of interest.

Since banks base their lending decisions on real (taking into account

the rate of inflation) rather than on nominal interest rates, they will not

lend unless they can charge an interest rate which is at least equal to the

rate of inflation during the period of the loan. In such a situation, the

monetary authorities cannot stimulate the economy by lowering interest

rates further. The alternative is to increase the money supply directly by

injecting liquidity into the financial system as the UAE Central Bank

has recently done. However, there is the real fear that most of this new

liquidity, about $30 billion, will be ‘trapped’ with banks because of the

low rate of interest. An alternative explanation of the recent economic

slowdown is that the economy has suffered from the recession portion

of the business cycle brought on by high rates of inflation in Dubai

which can only be ‘corrected’ by allowing the recession to liquidate the

42 This ‘liquidity trap’ situation was also prevalent during the Great Depression in 1929, and during the Japanese recession in the late 1990’s.

57


‘wrong’ investments during the boom 43. In such a situation, govern-

ment intervention of any kind will worsen the recession or even delay a

much bigger one.

The financial sector in Dubai has also attracted highly skilled

professionals in the wake of the current global financial crisis. Interna-

tional branches of investment banks have set-up shop to cater for the

needs of high net-worth customers in the Gulf region by providing spe-

cialized ‘boutique’ services and acting as suppliers of capital to other

sectors, especially to the real estate sector. The current upgrading of the

financial infrastructure of Dubai will considerably increase overall fac-

tor productivity as businesses will be able to raise capital and benefit

from more diversified financial products. To reinforce the confidence

in the financial sector and to reassure investors, the Dubai government

recently injected $20 billion into the banking system to ease credit con-

cerns and provide liquidity. The recent global financial crisis has also

provided the opportunity for Dubai to boost its position as ‘the’ re-

gional financial hub by providing a highly conducive business environ-

ment to enable the financial sector to innovate new products tailored to

the specific needs of high net-worth Gulf investors.

43 This is also sometimes known as the Austrian explanation.

58


Economic Policy vs. Commercial Policy

Economic Policy Effectiveness

When economic commentators speak of economic policy, they

usually speak in very general terms such as the establishment of new

companies, increases in investment, changes in consumer spending, in-

creases in exports and imports, and the like. Even policies at the firm

level are considered as economic policy. For an economist, economic

policy tries to influence underlying macroeconomic variables using the

tools of economic policy to steer the economy to desired growth paths.

Given limited tools and instruments in a market economy, policy mak-

ers must usually choose between different macroeconomic priorities

and do not have the luxury of choosing optimum policy tools due to

trade-offs. For example, if policy makers target lower inflation, it will

be at the expense of higher unemployment. If they wish to increase

consumer spending, it will be at the expense of higher budget deficits,

and so on. But all policy makers strive to achieve macroeconomic sta-

bility44 using ‘standard’ economic policy tools, knowingly and some-

times unknowingly, such as monetary policy, fiscal policy, trade policy,

and labor policy. Monetary policy deals with controlling the money

44 Macroeconomic stability exists when key economic relationships are in balance—for example, between domestic demand and output, the balance of payments, fiscal revenues and expenditure, and savings and investment. These relationships, however, need not necessarily be in exact balance. Imbalances such as fiscal and current ac -count deficits or surpluses are perfectly compatible with economic stability provided that they can be financed in a sustainable manner.

59


supply through changes in the interest rate. Fiscal policy has to do with

government expenditure and revenue. Trade policy tries to affect the

terms-of-trade with its trading partners by changing (or fixing) ex-

change rates; and labor policy tries to affect underlying labor market

forces to influence the wage rate (the price of labor).

The effectiveness of economic policy, as demonstrated in many

financial and economic crises, is not as certain as policy makers would

like to perceive45. There are simply too many variables in the real

world, and too many psychological reasons (‘expectations’) for policy

tools to have a full impact on economic aggregates (such as on GDP,

inflation, unemployment). But even under ‘ideal’ circumstances, the ef-

fectiveness of economic policy is based on behavioral assumptions. For

example, if the responsiveness of consumers to changes in taxes is not

very strong, then a given decrease in taxes will not have much effect on

economic growth. Similarly, if a change in the money supply is not re-

sponsive to changes in the interest rate, then a decrease in the rate of in-

terest will not increase liquidity. There are many such examples in eco-

nomic policy where its effectiveness depends on the validity or ‘robust-

ness’ of underlying assumptions. The effectiveness of economic policy

in Dubai is further complicated by the fact that economic policy (mone-

tary, fiscal, trade, and labor) is conducted by the federal ministries at

the country level. The money supply is controlled by the Central Bank

of the UAE; fiscal policy is determined by the federal government;

trade policy is determined by trading relationships with the UAE; and

45 For an extensive discussion on the effectiveness of economic policies and the rea-sons as to why policy makers cannot always choose ‘optimum’ solutions, see the sec-tion on ‘The Luxury of Choosing First-Best Solutions’.

60


labor policy is determined by the UAE Ministry of Labor. This unique

situation has somewhat reduced Dubai’s degrees of freedom in con-

ducting independent economic policies as we know it.

Nevertheless, Dubai has been successful in conducting its own

economic policies, sometimes in coordination with other emirates, to

achieve desired outcomes46. The ineffectiveness of monetary policy, for

example, is due to the fixed exchange rate with the US dollar which

forces the UAE interest rate to move in the same direction of the US

rate of interest. The increase in the money supply, on the other hand, is

influenced more at the domestic level through changes in banking regu-

lations, and by increasing the confidence in local banks, institutions,

and financial markets. But even under these constraints, the Dubai gov-

ernment was recently successful in issuing government bonds to fi-

nance its economic growth47. Trade policies have focused on increas-

ing trade through bilateral agreements, the expansion of existing ports

and the construction of new ones, and by positioning Dubai as a trading

hub for multinational companies. Fiscal policies have tended to be on

the expansionary side given the rapid development of the Dubai econ-

omy and the continuous upgrading of its infrastructure. In June 2009,

the government announced a further expansionary stimulus by an-

nouncing a 30 percent reduction in most of its fees to further boost eco-

nomic activity. And finally, labor policy has been conducted by wage

agreements with labor exporting countries (primarily with Southeast

46 Note that ‘commercial policy’- those to do with rules and regulations to affect mar-ket structures at the industry and sectoral levels - is extensively discussed in the next section. 47 In early 2009, the Dubai government issued $20 billion worth of bonds which were subsequently purchased by the Abu Dhabi government with an annual yield of 4%.

61


Asian countries) and by enforcing labor substantially improving work-

ing conditions, especially for the unskilled segment of the labor force.

But perhaps the two most important policy issues that have been

the focus of much attention in recent months are the GCC currency uni-

fication and the introduction of a value added tax (VAT). The main ar-

gument for the introduction of a common currency in GCC countries is

that it will reduce foreign exchange costs of intraregional transactions48.

A unified currency will eliminate foreign exchange commissions paid

by firms and households when exchanging regional currencies. A uni-

fied currency will also eliminate uncertainty about bilateral exchange

rates. The ultimate benefit of eliminating these costs and uncertainties

is that it will increase intraregional trade and investment, and will con-

tribute to advance the region’s economic integration. In addition, since

trade between GCC countries is mostly in non-oil goods, the elimina-

tion of these costs will enhance non-oil sectors which are important

strategic objectives of GCC countries. But the benefits of a currency

union will be relatively small because of the relatively small size of in-

traregional trade between GCC countries49. Moreover, current exchange

rates between GCC countries are already virtually fixed because of

their fixed exchange rate systems with the US dollar (except in

Kuwait). Nevertheless, when the benefits of a currency union are evalu-

ated in terms of the contribution to the non-oil sector, the benefits are

48 In May 2009, the UAE exhibited ‘reservations’ in joining the currency union due to disagreements on the location of the GCC Central Bank. Although the UAE was the first country to propose the establishment of the GCC Central Bank on its soil, other GCC members chose Saudi Arabia (Riyadh) as its location. 49 The value of intraregional exports represented less than 10% of the total value of all GCC exports compared to over 50% in the European Union. See Jadresic (2002).

62


significant. When both crude and refined oil exports are excluded from

intraregional trade data, total exports among GCC countries increases

to over 40%, and for some countries such as Kuwait and Qatar, this fig-

ure is as high as 60%50.

One major disadvantage of a currency union is that countries

have to give up the option of unilaterally changing their exchange rates.

This is considered a disadvantage because there is always the possibil-

ity that a country might face a large current account deficit and will not

be willing to bear the full adjustment costs of lower nominal wages and

lower prices in a currency union. Another cost of a regional currency

union is that countries will lose the independence and control of their

domestic monetary policies. Although one could argue that the effec-

tiveness of monetary policy is already very limited under the current

fixed exchange rate system with the US dollar, countries can still influ-

ence domestic liquidity by printing their individual currencies, some-

thing that would not be possible in a currency union. But perhaps one

of the greatest fears of joining a currency union is that countries that

face no fundamental economic problems of their own may end-up suf-

fering negative monetary spillovers from macroeconomic imbalances

of other countries. In other words, the monetary union may be forced to

modify existing monetary and exchange rate arrangements for the

‘common good’ despite the objections of an individual country which

may ultimately experience the adverse effects of the changes in these

50 Rose (1999) has found that after controlling for variables such as geographic prox-imity, existence of established trade agreements, language, common cultures and his-tories, two countries that share the same currency trade 3 times as much as they would with separate currencies.

63


arrangements. However, given that all GCC countries are oil and/or gas

exporters, an external shock will affect all countries such that their in-

terests will eventually converge. Moreover, they may always jointly de-

cide on changing the peg for the common currency in the face of com-

mon external shocks.

A second policy issue which has gained much attention in re-

cent months is the introduction of a value added tax (VAT). The gen-

eral concern is that this tax will ultimately lead to higher prices and add

extra pressure to already rising rates of inflation. A VAT is a tax on all

sales of goods and services at every stage of the production process. Its

defining feature is that it credits taxes paid by firms on their inputs

against taxes they charge on their sales – i.e. the government collects

revenue on “value added” throughout the production process. Its distin-

guishing feature is that it does not affect the prices firms pay for inputs

because the tax is ultimately passed-on to the final consumer. Since it

does not affect input prices, it does not cause any production distortions

and does not create “cascading”51.

Perhaps the biggest advantage of the VAT is that it is very prac-

tical to implement since it is collected at every stage of the production

process. As a simple example, suppose firm X sells its output to firm Y

for a price of $100, which in turn sells its output to the final consumer

for $300. Assume now that there is 10% VAT. Firm X will now charge

firm Y $110, remitting $10 to the government in tax. Firm Y will

charge consumers $330, remitting tax of only $20 (output tax of 30$

minus a credit for the $10 of tax charged on its inputs purchased from

51 Cascading is a “tax on tax” when a tax is levied on both the output and on the final inputs used in the production of that output.

64


firm X). The total revenue of the government is therefore $30. Al-

though this is equivalent to a 10% tax on final sales of $300, this

method of collection secures the revenue more effectively. In other

words, if firm X, for some reason, were to omit charging tax to firm Y,

the government would still collect $30 from firm Y. If firm Y were to

omit charging the tax, the government would at least collect the $10

from firm X. The advantage of VAT over a standard sales tax on final

consumption is that if the final retailer (firm Y) somehow were able to

avoid paying tax, then the government would still collect $10 from firm

X. With a sales tax, the government would receive nothing52.

Despite the problems faced by economic policy makers in gen-

eral, and problems associated with the definition of economic policy as

economists understand it, Dubai has been highly successful in formu-

lating effective economic policies53. This is primarily because policy

implementation in Dubai is taken very seriously with strict timelines

and monitoring mechanisms. The effectiveness of economic policies in

most emerging economies is hampered by poor enforcement and

‘loose’ implementation due to bureaucratic red-tape and the lack of

qualified professionals. Even in developed economies, the effectiveness

of economic policy is hampered by special interest groups with their 52 The ultimate payer of the tax is the consumer. Thus, there is some justification about the concern on rising costs-of-living. For a detailed yet very simple discussion on VAT, see Liam E. et al (2002). 53 The effectiveness of economic policy can be measured either in a partial equilib-rium model or a general equilibrium model. In the former, the modeler looks at the ef-fect of the policy on a single market in isolation from the rest of the economy. Such models are common in the analysis of the impact of a policy on a specific industry. In a general equilibrium model, the analyst looks at the effect of the policy on the whole economy by modeling inter-industry transactions and linkages between different eco-nomic agents such as firms, households, the government, and the rest of the world.

65


own objectives, and by the fact that governments may be ‘voted out’

and will not have the required time to implement a given policy. More-

over, any economic policy will have ex-post undesirable outcomes af-

fecting economic groups disproportionately and which cannot be deter-

mined until the policy is fully implemented ‘on the ground’. The secret

of Dubai’s success in increasing its economic policy effectiveness is

that these undesirable outcomes are quickly rectified through the estab-

lishment of specialized task-forces, working-groups, committees, and

other specialized agencies. Perhaps a good example of the effectiveness

of economic policies in Dubai is the current implementation of the

Dubai Strategic Plan (2015) which contains hundreds of initiatives and

action plans to triple Dubai’s GDP to over $100 billion by 2015. The

DSP(2015) is having some undesirable, yet expected impacts such as a

rising cost-of-living and falling real wages which are being rectified by

a special task-force on inflation and the signing of agreements with la-

bor exporting countries to increase wages.

66


Commercial Policy and Market Structure

Notwithstanding the limitations of economic policy in the tradi-

tional sense, Dubai has adopted commercial policies in the form of

laws, rules, regulations, and projects to attract foreign investment and

affect market structures. Perhaps the most important of these commer-

cial policies has been the establishment of Free Zone Areas as interna-

tional business hubs in a wide range of sectors and services such as

Dubai Airport Free Zone, Dubai Healthcare City, Dubai Knowledge

Village, Dubai Industrial Park, and much more54. Dubai is well placed

midway between Europe, Asia, and Africa and provides its clients with

a huge customer base of over 2 billion people. An outstanding logistics

infrastructure is one of the free zones’ key strengths. Dubai has also the

world’s 7th largest seaport and the upcoming Al Maktoum International

Airport will be the world’s largest cargo airport. Free zones also pro-

vide a range of facilities which include pre-built modern warehouses

ready for lease, office space in various sizes, and plots of land from

small and large scale operations such as manufacturing and extensive

warehousing. Free zones enjoy a wide range of commercial incentives,

from a 100% foreign ownership, zero corporate and income taxes for a

period of 50 years, to exemptions from local labor restrictions, full

repatriation of profits and capital, and no foreign currency restrictions -

attributes seldom found in other parts of the world.

The two commercial policies which have had the greatest im-

pact on Dubai’s economic growth are the Trade Agency Law and the

54 For a comprehensive list of all free zones in Dubai see eyeofdubai.com

67


Company Law55. The Trade Agency Law grants special privileges to

UAE nationals to import specific goods. The law has been criticized on

various grounds for restricting competition. Recently, the government

has been considering the enactment of a Competition Law to limit the

goods that UAE nationals can import, and some items, especially food

items, have been exempted from this law to increase the availability

and choice of these products due to the rising cost-of -living. The Com-

pany Law restricts foreign ownership of companies to 49% of total cap-

ital except in Free Zone Areas. Some sectors, especially the service sec-

tor such as education, healthcare, and technology, have been exempted

from this requirement on the grounds that such restrictions have held

back human capital development by discouraging highly skilled profes-

sionals to start their own businesses in areas other than in the free

zones. Despite the many advantages that these laws provide to foreign

companies, both the Trade Agency Law and the Company Law have

been unfairly criticized by international organizations, especially the

World Trade Organization, on the grounds that they discriminate

against foreigners and distort resource allocation56.

Many other commercial policies, initiatives, and projects are

also formulated and implemented by the various Dubai government de-

partments and agencies such as the Department of Economic Develop-

ment (DED), Dubai Chamber of Commerce and Industry (DCCI),

Dubai Ports, Customs and Free Zone Corporation, and Dubai Munici-

55 See UAE Federal eGovernment Portal http://www.government.ae/gov/en/biz/start/incorp.jsp

56 See World Trade Organization (2006).

68


pality, to name just a few57. The Department of Economic Development

was established with a mission to contribute to economic planning and

business sector regulation by recommending policies and preparing de-

velopment programs and projects. Its most important goal is to create a

competitive investment environment to attract local and foreign invest-

ment, and to organize the business sector according to best practices.

To achieve this goal, DED has been instrumental in conducting special-

ized studies on different economic sectors, recommending policies and

processes to attract investments, performing regular reviews of its rules,

regulations and procedures, and becoming close partners with the pri-

vate sector. DED has also several projects to enhance competitiveness

and human capital. ‘Intilaq’ (which means ‘take-off’ in Arabic) is a

project initiated back in 1999 to encourage all UAE citizens residing in

Dubai to start their own home-based businesses within the framework

of certain regulations and professions to preserve the residential charac-

ter of neighborhoods while permitting certain limited commercial activ-

ities such as fashion design, educational services, and brokerage ser-

vices. DED has also launched a ‘Human Development Initiative’ which

includes a number of projects and awards that aim at upgrading and de-

veloping human resources.

The Dubai Chamber of Commerce and Industry (DCCI) started

its activities in 1965 with only 450 members, and by the end of 2007

had over 100,000 registered members representing all economic sec-

tors. DCCI has been continuously streamlining its processes to simplify

57 For a comprehensive list of all Dubai government departments and agencies and links to their respective websites, go to www.dubai.ae

69

http://www.dubai.ae/


and expedite the setting-up of businesses in Dubai by acting as an in-

formation and research center by providing business documentation, of-

fering legal services, facilitating business networking opportunities, and

providing effective business solutions to the business community. The

Dubai Ports, Customs and Free Zone Corporation encompasses Dubai

Ports World (DP World), Dubai Customs (DC), Jebel Ali Free Zone

Authority (JAFZA), and Dubai Multi Commodities Center (DMCC).

Terminals in Dubai are among DP World’s flagship facilities and are

ranked as the 7th top container port in the world handling 11 million

TEU of cargo in 2007. Dubai Customs facilitates free trade and helps

secure the integrity of Dubai’s borders. Its major duties are the collec-

tion of customs revenue and the administration of trade measures. It has

also implemented information networks to minimize customer hassle

and manage risk efficiently. Jebel Ali Free Zone Authority (JAFZA) is

spread over an area of 50 square kilometers and ranks among the

world’s largest and fastest growing free zones. Since 2000, JAFZA has

grown by over 3 times its original size and is situated between Jebel Ali

Port and the upcoming Al Maktoum International Airport. It is the

only free zone in the world located between these two major logistic

enablers, and with a six lane highway, JAFZA will facilitate the trans-

portation of goods from sea to air in just 20 minutes. The Dubai Multi

Commodities Center (DMCC) was created to establish a commodity

marketplace in Dubai and provide a full range of facilities for gold, pre-

cious metals, diamonds, colored stones, energy, and other commodities.

Its objective, among others, is to facilitate the integration of the entire

value-chain of its key segments by providing a highly supportive busi-

70


ness environment. DMCC is a Free Zone Area offering participants

100% ownership, a 50 year tax exemption, and a one stop shop facility

for processing all documentation including immigration, registration,

and licensing.

The highly supportive role of the government through these

commercial policies has attracted a large number of firms into the ser-

vice sector58, especially in the retail, hospitality, finance, and real estate

sectors, creating a very healthy competitive market structure59. These

markets in Dubai are characterized by fierce competition, primarily

through marketing and advertisement campaigns, to differentiate their

products in terms of quality, taste, preferences, and other attributes re-

sulting in the provision of a wide variety of goods and services catering

to the distinct needs of various income groups especially in the retail

and hospitality service sectors. On the other hand, the market structure

in the telecommunications sector can be described as an oligopolistic

structure in which there are only 2 service providers, Etisalat and du,

which, unlike oligopolies in the traditional sense, do not collude but

compete to improve their services. Some service sectors, such as utili-

ties, are ‘natural’ monopolies because of strategic reasons but do not

58 The relative growth of the manufacturing sector has been slow because of Dutch Disease effects through an appreciation of the real exchange rate – i.e. a unit of the foreign currency now buys less domestically manufactured goods. This has reduced the competitiveness of the manufacturing sector. 59 Market structure refers to ‘the degree of competition’ in a specific market which ranges from perfect competition to monopoly. In a perfectly competitive market, there are many buyers and sellers dealing with a single homogeneous product. In a monop-oly, there is a single producer. In the real world, however, market structures fall somewhere between these two extremes such as monopolistic competition where there are many buyers and sellers but a differentiated product, and oligopoly in which few firms (2 to 10 depending on the size of the existing market) dominate the market.

71


act as typical monopolies in the sense that they do not restrict output to

charge higher prices. This is especially true of the Dubai Electricity and

Water Authority (DEWA) which has relatively low tariff rates, espe-

cially if one takes into account the scarcity of water resources in the re-

gion. Moreover, the price of gasoline is much lower than prices in other

countries because these prices are heavily subsidized by the govern-

ment. Most ‘outsiders’ incorrectly think that Dubai is rich in oil just be-

cause it is in the Gulf. On the contrary, Dubai has very limited oil re-

sources and purchases most of its oil needs at international prices.

72


Governance and First-Best Solutions

Governance Indicators

The secret of Dubai’s economic success is also explained by the

intimate involvement of the Dubai government in the provision of

goods and services to consumers and businesses alike. Governments,

by definition, are inefficient because they do not allocate their re-

sources using the price mechanism. In a market economy, the price sys-

tem acts as a powerful signaling mechanism ‘telling’ producers what

and how much to produce. In other words, in a market economy, de-

mand creates supply. If a typical government wishes to supply a prod-

uct or a service to the public, its ‘price’ is not determined by demand

and supply factors. This misallocates resources by producing goods and

services that are not demanded by the public, or by under-producing

and creating shortages. For this reason, the Classical school of thought

holds the view that the role of the government should only be a regula-

tory role such as policing and judiciary, and should not interfere in the

market system. On the other hand, the Keynesian school of thought ad-

vocates government intervention in the market system through fiscal

policies (taxes and government expenditure) to help achieve desired

economic outcomes60. Although in the real world there is always some

60 Prior to the start of the Great Depression in 1929, the Classical (or laisez faire) school of thought was the dominant school arguing that any market inequalities will be automatically corrected by the ‘invisible hand’ through the forces of demand and supply, and there is no need for government intervention. However, the high and per-sistent levels of unemployment during the Great Depression were not eliminated through automatic market corrections and the government had to interfere extensively through its use of Keynesian expansionary fiscal policies by reducing taxes and in-

73


form of government intervention, the recent collapse of the global fi-

nancial system and the subsequent intervention of governments to bail-

out these financial institutions demonstrate the dominance of Keyne-

sian government intervention over the classical ‘hands-off’ approach.

The secret of Dubai’s economic success has been the government’s

deep involvement in the market and its genuine desire to improve its

performance; again, a highly counterintuitive approach compared to the

role of many other governments in emerging economies.

Governance is defined as ‘the manner in which public officials

and institutions acquire and exercise the authority to shape public pol-

icy and provide goods and services’. 61 The difficulty in measuring gov-

ernment performance is that unlike the output of commercial entities,

the ‘output’ of the government is a highly subjective concept influ-

enced by the views and opinions of individuals, firms, and experts. As

Einstein’s quote reminds us, “not everything that can be counted

counts, and not everything that counts can be counted”, Dubai has been

highly successful in choosing those indicators that matter most. In prin-

ciple, all governance indicators fall into two groups: rules-based and

outcome- based indicators62. In the former, we determine the existence

(or non-existence) of a rule, and in the latter we look at the implemen-

tation of the rule ‘on the ground’. For example, in a rules-based indica-

creasing government expenditure. 61 Although there are many definitions of governance depending on the level of devel-opment and the political structure of a country, most definitions agree on the impor-tance of a capable state operating under the rule of law. For an extensive and practi-cal discussion on governance and its many indicators, see World Bank (2007). 62 For a detailed discussion and list of rules-based and outcome-based indicators, see Kaufman and Kraay (2007).

74


tor we determine if there are rules ‘on the book’ on, say, compulsory

education, and we ‘map’ this rule to outcomes ‘on the ground’ by ask-

ing the public through opinion surveys if it perceives the country to

have a good education system 63.

Dubai has been very innovative in the use of governance indica-

tors to measure and evaluate government performance through various

programs and initiatives64 such as the Dubai Government Excellence

Program (DGEP), the Dubai Government Performance Measurement

System, the Mohammed bin Rashid Program for Leadership Develop-

ment (MBRPLD), and many innovations in e-Government to improve

performance and delivery of public services. Most of these programs

and initiatives are outcome-based governance indicators. The most no-

table of these programs is the Dubai Government Excellence Program

(DGEP) which was initiated at the Department of Economic Develop-

ment (DED) in 199965. Its main objective, among many others, is to es-

tablish a guiding reference and benchmarks to measure the progress in

effecting change and evaluate the performance of public agencies ac-

cording to established criteria in different categories divided into ad-

63 The most frequent criticism of such indicators is that it is impossible to trace back a specific outcome ‘on the ground’ to a specific rule ‘on the books’ because there are many other variables that can influence the outcome. Moreover, there is no clear de-marcation line between rules-based and outcome-based indicators, and both types of indicators are highly subjective and are based on value-judgments. 64 For an excellent discussion on the Dubai experience in governance, see Al Yousuf (2005). 65 The original name of the program was the Sheikh Mohammed bin Rashid Govern-ment Excellence Award which was conceived as an innovative impetus to speed up the pace of change and drive all administrations towards improvements, increased ef-ficiency and effectiveness.

75


ministrative excellence and employee excellence 66. In 2002, the ‘mys-

tery shopper’ was introduced to the evaluation process, and in 2003 the

concepts of employee satisfaction and departmental social responsibil-

ity for the community were added. Also in 2003, a category called ‘Ex-

cellence in Departmental e-Government’ was added with the aim of

achieving a paperless public administration. In 2004, the original

model67 was changed to the European Business Excellence model

which enhances innovation, learning, and transparency. Today, in a

highly publicized ceremony broadcasted nationwide, winners are

granted promotions and substantial monetary rewards for their achieve-

ments. After seven years of its launching, DGEP commissioned the ser-

vices of a team of experts from Cranfield School of Management in the

UK to measure the impact of the excellence models on public adminis-

tration and users of public services. Their study concluded that DGEP

is credited as being the ‘key driving force’ behind the remarkable per-

formance of the public sector. To ensure a more professional approach

to the collection, analysis, assessment and monitoring of performance

results, the government has recently installed a state-of-the-art perfor-

mance management software to assist departments in the preparation

and submission of their applications for evaluation.

The government has also achieved remarkable progress in the

application of electronic on-line tools in the provision of a wide range

of services to the general public. The Dubai e-Government initiative

was launched in 1999 and currently handles 90% of about 2000 public

66 For an in-depth discussion of the inception of this program and its subsequent mod-ifications, see Makharita, R. (2005). 67 The original model was an adaptation of the US Malcolm Baldrige model.

76


services provided by the government. For example, Government e-Ser-

vices Statistics (GeSS) measures the levels of e-Enablement from over-

the-counter services to e-Services by government departments; the e-

Complain service allows all customers to electronically record and

track their complaints against government entities which are then for-

warded to the respective departments to improve customer satisfaction;

e-GovCards is a convenient, flexible, and highly secure alternative to

carrying cash, and has all the advantages of a standard payment card in

addition to unique government-related features; and mPay enables one

to make payments using the mobile phone. All of these electronic ser-

vices have considerably reduced transaction costs and increased com-

petitiveness with the ultimate objective of increasing overall economic

productivity. According to the United Nations international classifica-

tion, Dubai has reached the fifth and final stage in the project lifecycle

of e-Governance by offering fully integrated services through a single

portal, namely, www.dubai.ae

To sustain the development of the Dubai economy and further

improve governance, the government has also been supportive of creat-

ing ‘future leaders’ to achieve the ambitious targets of the Dubai Strate-

gic Plan (2015), and beyond. The Mohammed bin Rashid Program for

Leadership Development (MBRPLD) is a highly innovative program

comprising of four categories – Young Leaders, Promising Leaders,

Government Leaders, and the Director-General Majlis. The overall aim

of this program is to foster leadership skills in UAE nationals to ensure

local sustainable development in partnership with leading institutes

such as INSEAD, Harvard, Duke Corporate Education, and the like.

77


The program was launched in 2003 and has produced over 150 gradu-

ates who are employed in government and semi-government organiza-

tions. Some graduates have also been employed in the private sector

and a number of them are currently leading new projects and establish-

ments. The distinguishing feature of MBRPLD is that it tries to achieve

balanced growth in various fields of leadership by providing the oppor-

tunity to all UAE nationals to develop their ‘hidden’ leadership abilities

in their specific areas of interest. In this way, each future leader is given

a chance to distinguish himself or herself in their chosen field of exper-

tise. The program is regularly updated to take into account regional and

international developments such as the recent launching of a training

program on Business and Finance Fundamentals in response to the cur-

rent global financial crisis.

It is also important to note that the deep involvement of the

Dubai government in the economy does not imply that the government

will always act as a lender of last resort to bail out under-performing

establishments. The raison d’être of the government’s interference in

the economy of Dubai is to increase competition by creating a healthy

competitive environment for all, both private and public establish-

ments, so that they can compete on a level playing field. The ‘moral

hazard’ problem – a situation in which large establishments perceive

that the government will always bail them out – was clearly demon-

strated in the bail-out of US and other financial institutions.68 The risk

68 The argument for bailing-out large establishments is that their collapse will have ripple-effects throughout the rest of the economy and cause irreparable damage. This argument is misleading since the financing of the bail-out is harmful by itself since it is paid for by the public in higher taxes.

78


of bailing out inefficient establishments, whether private or public, is

that this would breed more inefficiency and ultimately decrease overall

productivity. Perhaps the best example of the absence of the ‘moral

hazard’ problem in Dubai is the recent fall in the price of Emaar stocks,

a partially government owned real estate developer, in which the gov-

ernment has not interfered to boost its stock price. This has forced

Emaar to cut labor costs by laying-off hundreds of workers and restruc-

ture to increase profitability. In other words, under-performing estab-

lishments, even public ones, do not get special treatment in the highly

competitive Dubai market. Again, a highly counterintuitive approach

compared to the support granted to inefficient ‘natural’ monopolies in

most other emerging economies.

79


The ‘Luxury’ of Choosing First-Best Solutions

The secret of Dubai’s economic success can also be explained by

the government’s ability to choose first-best optimum solutions to pressing

economic problems. In most advanced economies, first-best solutions are

determined by social science researchers using a wide range of sophisti-

cated ‘models’ to replicate the effects of a specific policy which ‘theoreti-

cally’ enables them to choose the ‘optimum’ policy among many alterna-

tives. But models are nothing but rough representations of the workings of

a real complex economy with a countless number of unpredictable vari-

ables which can influence the outcome of a given policy69. Even if model-

ers were able to accurately capture these real world variables in their pol-

icy analyses, there are certain aspects of the real world policy making

process that are incompatible with the utilization of research. For example,

research requires a clear definition of the problem and the variables to be

measured which is not always possible because governments tend to have

loosely defined and multiple, even contradictory, objectives. Moreover,

the need for research often becomes apparent too late because of other

more urgent priorities. It is also important to realize that in the real world,

especially in Western societies, policy decisions are arrived at through a

bargaining process to satisfy the political needs of the ‘opposition’ or

some special interest group. For all these reasons, accuracy and specificity

are sacrificed at the expense of ‘broad statements of principles’ declared

69 This does not mean that models are not important. On the contrary, models simplify the real world by focusing on variables that matter most, especially in determining the direc-tion and magnitude of a specific policy change. In other words, just like travelling from one city to another, we do not need to know every single landmark on the way. The di-rection and distance of the route will get us there.

80


by governments that are not easily amenable to rigorous research and anal-

ysis.

Another important aspect of the policy making process is that the

objectives of researchers and government policy makers are not always the

same70. Policy makers in government are more interested in distributional

issues such as ‘winners’ and ‘losers’, whereas policy researchers are con-

cerned with efficiency issues such as the efficient allocation of scarce re-

sources. Moreover, most policy makers in government tend to have back-

grounds in law and thus favor legislative instruments as opposed to using

incentives to affect economic behavior. University research is also not

very suitable for policy makers because it takes much longer to produce

research results at academic institutions than a policy maker in govern-

ment with a short deadline can tolerate71. Nevertheless, there are three con-

ditions under which first-best solutions are most likely to be adopted by

governments72. The first of these conditions is when research is concerned

with critical future outcomes such as forecasting population growth rates

or rates of growth of the economy. The second condition is when there are

powerful competitive pressures and incentives to innovate. And the third

condition is when government departments are highly accountable and

must somehow justify the policy decisions they take. Bearing in mind that

first-best solutions can be adopted by governments under these conditions,

it is indeed encouraging to see that Dubai satisfies all three conditions.

70 See Glover, D. (1991). 71 This does not mean that university research is not important. It simply implies that uni-versity research is ‘research for knowledge’ as opposed to ‘research for action’ which the policy maker in government requires in a relatively short period of time especially when the economy is in a recession. 72 See Faulhaber and Baumol (1988).

81


With respect to the first condition, a big chunk of policy research

in Dubai has been concerned with forecasting critical future outcomes for

planning purposes. For example, the Dubai Strategic Plan (2015), cur-

rently being implemented by the government, is based on several assump-

tions on the rate of growth of population, on the number of incoming

tourists, on the cost-of-living, on the supply of housing, and many other

determinants of the successful implementation of the DSP(2015). We also

need to bear in mind that the Dubai economy is currently a ‘supply-driven’

economy where the government is building both the soft and hard infra-

structures of the economy to attract investors, tourists, and different types

of labor. The objective of the DSP(2015) in the long-run is to transform

Dubai into a ‘demand-driven’ economy in which production of both goods

and services will be determined by tastes, preferences, consumer behavior,

and expectations. For policy purposes, it is much easier to forecast future

critical outcomes in a ‘supply-driven’ than in a ‘demand-driven’ economy

because there are fewer uncertainties in a ‘supply-driven’ economy. For

this reason, the Dubai government has been able to choose first-best opti-

mum solutions from many alternatives. Moreover, critical future out-

comes, especially in the short-run, are much more relevant in a rapidly

changing economy because the DSP(2015) can be modified, especially

during the initial stages of its implementation, to achieve its highly ambi-

tious objectives73.

The Dubai economy is also a highly competitive economy and

there are numerous incentive structures in place to encourage innovation

in both government and industry. The fulfillment of this second condition

73 In May 2009, the government announced that the targets and assumptions of the Dubai Strategic Plan (2015) were to be revised and adjusted to current global market conditions.

82


is self-explanatory since the very definition of ‘competition’ necessitates

the choice of first-best solutions to achieve optimum outcomes in a com-

petitive environment. These powerful competitive forces have been repeat-

edly demonstrated throughout the book either in the form of market forces

beyond the control of the government (Dutch Disease effects) or in the

form of incentive structures such as the various excellence programs and

awards to encourage innovation in governance and the establishment of

‘technology’ clusters to encourage innovation in industry. And finally, the

third condition of accountability of government departments was exten-

sively discussed in the previous section. The fulfillment of all three condi-

tions, by no means an easy and ‘luxurious’ task, has enabled the Dubai

government to choose first-best optimum solutions.

83


Dubai Strategic Plan (2015) and Sustainability

Building-Blocks of DSP (2015) 74

Dubai’s economic growth has been truly remarkable with double-

digit real GDP growth rates and a relatively high per capita income despite

negligible dependence on oil. The driving force behind Dubai’s economic

performance has been the government through investments and other ini-

tiatives supported by the private sector. Economic performance at the sec-

toral level has also been impressive and has been led by the trade, con-

struction and real estate sectors with good signs of successful diversifica-

tion. In particular, since 2000, real GDP has been growing at a com-

pounded annual growth rate of 13%, by far exceeding that of its GCC

counterparts. The Dubai economy has also been growing faster than the

emerging economies of China and India, and the developed economies of

Ireland, Singapore, and the US.

Much of Dubai’s current success has been a result of its bold and

visionary leadership and innovative human resources, mainly driven by

government policies aimed at improving the business and investment envi-

ronment, in addition to initiatives to establish specialized zones and

megaprojects such as Internet City, Media City, Healthcare City, the Palm,

Dubailand, and much more. These developments ensured a leading role

for Dubai and help attract excess regional liquidity in the form of foreign

direct investment. Economic growth has also been fueled by private sector

participation in developing sectors for which the government has set the

74 This section follows closely The Executive Office (2006). Highlights: Dubai Strategic Plan (2015), Dubai… where the future begins. Dubai, United Arab Emirates.

84


stage by establishing a conducive business environment, coupled in many

instances with heavy initial investments to boost private sector confidence.

Other supporting factors are supply-side factors such as availability of la-

bor and land for major real estate projects, the existence of efficient gov-

ernment services, a solid institutional framework and good mechanisms

for service delivery, strong laws and regulations, excellent infrastructure, a

strategic location coinciding with the rapid rise in global trade especially

in China and India, and openness to other cultures giving Dubai a reputa-

tion as a safe and comfortable place to live and do business. These factors

have put Dubai’s real per capita GDP at $31,104 in 2005 with an annual

average growth rate exceeding 6% over the 2000 - 2005 period75.

Economic performance at the sectoral level has also been impres-

sive. The non-oil sector has played a more prominent role since 2005 with

a 95% contribution to GDP, as compared to 90% in 2000, and 46% in

1975. This was mainly the result of the reduced dependence on oil as well

as a deliberate policy of diversifying the economy in favor of non-oil sec-

tors in which both the overall business environment and sector-specific

programs have played vital roles. The service sector has been the key

driver of economic growth with an annual growth rate of 21% since 2000,

constituting $27.6 billion or 74% of Dubai’s current GDP. In particular,

the trade sector has experienced the highest increase in the share of GDP.

Although the contribution of the manufacturing and oil & gas sectors has

decreased, the manufacturing sector has grown by an average of 12%

75 Dubai’s per capita income today compares very favorably to that of many developed countries such as Singapore’s ($26,836) and Hong Kong’s ($25,493), countries which re-quired a much longer period of time to reach their current high levels of GDP.

85


since 2000. The construction and real estate sectors have also exhibited

share gains primarily due to the availability of land, labor, domestic and

foreign capital, and changes in regulations.

Dubai’s current GDP mix is very favorable as its strongest sectors

by international standards happen to be highly conducive to future global

growth. These sectors are tourism, transportation, construction, and finan-

cial services, and are well-placed to constitute the focal point of Dubai’s

future growth path within the economic development sector plan. Building

on Dubai’s remarkable economic performance and future trends, eco-

nomic targets for 2015 have been set and are classified into the following

categories: (1) Economic growth: sustain a real GDP growth rate of 11%

per annum for the next 10 years and increase real GDP per capita to

$44,000 in 2015; and (2) Enhanced labor productivity and sector develop-

ment: increase productivity by 4% per annum, move existing sectors of

strength to new frontiers (both domestically and internationally), create

new sectors of strength with sustainable competitive advantage, and pro-

mote innovation to develop new sectors and increase productivity.

The recommended future strategic growth path is based on 6 com-

binations of sectors, or vertical building blocks, including, among others,

sectors such as tourism, trade, transportation, and financial services76.

These sectors were identified based on their current status, international

competitiveness, Dubai’s capacity to develop them, and local availability

of required factor conditions. However, targeting these building blocks

will not yield rapid and sustainable growth unless 7 horizontal enablers

for growth are addressed in parallel, namely, human capital, productivity,

76 These are strong sectors by international standards which are highly conducive to fu-ture growth.

86


innovation, cost-of-living and doing business, quality of life, economic

policy and institutional framework, and laws and regulations.

The strategic thrusts supporting the achievement of economic de-

velopment targets are described as: (1) Sector focus and development:

moving Dubai to a new growth path, coupled with further diversification

while maintaining focus on high-value added sectors that can boost overall

economic growth. (2) Productivity growth: transforming Dubai into a hub

of business excellence by raising the productivity of economic sectors and

maintaining high production quality standards. (3) Human capital excel-

lence: preparing Dubai’s workforce for the high-value, knowledge-driven

economy, which requires attracting and retaining highly skilled employers,

improving nationals’ qualifications, and increasing their motivation. (4)

Science, technology, and innovation capacity building: turning Dubai into

a vibrant science and technology hub in targeted sectors by supporting the

development of existing sectors and establishing the right environment for

nurturing the post 2015 economy. (5) Cost of living and doing business

management: ensuring and maintaining Dubai’s competitiveness by man-

aging the rising cost-of-living. (6) Quality of life improvement: establish-

ing Dubai as a preferred home for current and future residents by improv-

ing the well-being of citizens and residents and helping them live healthier

lives enriched with opportunities and choices. (7) Policy and institutional

framework excellence: striving for excellence in economic policy-making

and deployment through coordination with the federal government, provi-

sioning of adequate data, and strengthening the institutional framework

and capabilities. (8) Laws and regulations alignment: aligning Dubai’s

economic laws and regulations with international best practices and stan-

87


dards. The pursuit of the proposed strategic growth path will promote

GDP growth to $108 billion by 2015. This approach would strengthen

Dubai’s healthy sector mix by ensuring focus on key sectors while further

promoting diversification and ensuring reduced vulnerability to external

shocks, and a systematic integration into the regional and global economy.

To achieve these economic growth targets, it is estimated that 882,000 ad-

ditional workers are required to join the workforce by 2015, bringing total

employment to 1.73 million with a significant move towards higher skilled

employment.

Perhaps one of the most important attributes of the DSP(2015) is

that it is a ‘live’ document constantly being updated and modified to

changing regional and international conditions. During its formulation in

2005, the major thrusts of its growth path were also based on current and

expected developments in the rest of the world. Moreover, the DSP(2015)

is based on macroeconomic principles to ensure that priorities do not clash

and market forces are reinforced. The positive aspect of the DSP(2015) are

double digit economic growth, a carefully thought out strategy of diversi-

fication, a substantial increase in the share of Arabs in the labor force,

deeper integration of the economy both regionally and globally, and

strengthening of the ability of the economy to absorb and cushion the ef-

fects of external shocks through improved policy making and institutional

strengthening. On the other hand, the DSP(2015) faces many challenges

such as a declining share of nationals in the labor force, major human cap-

ital development challenges, continued reliance on imported unskilled la-

bor from South Asia, and the ability to attract and retain skilled workers

88


given the expected rise in the cost-of-living which is primarily caused by a

sharp increase in government spending to achieve its targets by 2015.

89


The Rising Cost-of-Living

The sustainability of the Dubai Strategic Plan (2015) depends

on, among other things, maintaining a stable level of prices to prevent

the erosion of purchasing power and attract high-skilled workers. The

rising cost-of-living in Dubai is an expected outcome because it is pri-

marily caused by the rapid pace of government spending as it builds

both the hard and soft infrastructures of a rapidly growing economy.

The rising cost-of-living is also fuelled by large capital inflows in the

form of foreign direct investment which has contributed significantly

towards the increase in the money supply which, in turn, has resulted in

an increase in consumer spending on both durable and non-durable

goods. The fixed-exchange rate system with the US dollar has also

caused an increase in the relative price of imports, especially the price

of imported products from euro zone countries, as the value of the US

dollar has fallen in recent years. But apart from these standard tradi-

tional causes of increases in the cost-of-living, prices have also in-

creased due to Dutch Disease effects noted earlier as resources have

shifted from tradable manufacturing sectors to non-tradable service sec-

tors which is evidenced by the dramatic boom in the real estate,

tourism, and financial sectors.

The standard policy prescription in most countries facing infla-

tionary pressures is to adopt contractionary monetary and fiscal policies

to decrease both the money supply and consumer spending. Contrac-

tionary monetary policies work by increasing the rate of interest to in-

crease the cost of borrowing and thus reduce business investment and

90


consumer spending. However, due to the fixed exchange rate system

with the US dollar, domestic interest rates closely follow US rates

which are currently at historically low levels. Moreover, monetary pol-

icy is conducted at the federal level by the Central Bank of the UAE

which considerably reduces the degrees of freedom available to Dubai

in controlling the money supply. Dubai has also limited instruments in

its fiscal policy toolkit to reduce aggregate spending due to the absence

of all forms of taxation. One of its few fiscal policy instruments is to re-

duce government spending but this would ultimately work against the

achievement of the ambitious growth targets of the Dubai Strategic

Plan (2015).

Dubai has adopted price controls, a highly controversial yet

counterintuitive policy, to control the rising cost-of-living especially in

the control of rents and prices of basic food items and intermediate in-

puts. In 2006, the government imposed a 15% cap on rental price in-

creases which has been progressively lowered to 7% in 2007, and more

recently to 5% in 2008 for tenants who have occupied their premises

for 2 years. The Ministry of Economy has also recently fixed the price

of cement at $4.35 per 50kg sack and began monitoring the price of ba-

sic food items imposing penalties on producers who ‘unfairly’ increase

prices. The biggest drawback of such price controls is that they discour-

age developers and producers to invest in these markets because of

their lower profitability as a result of fixing the price below the market

price. Price controls have been tried in many countries with disastrous

outcomes such as in the South Bronx in New York where landlords

could not afford to maintain their buildings which ultimately led to the

91


creation of urban slums. Price controls also encourage the creation of

‘black markets’ since they create an artificial shortage at the lower con-

trolled price77. Moreover, country experiences have shown that since

price controls are perceived to be a temporary measure, once they are

lifted, prices tend to ‘overshoot’ as landlords and producers try to

make-up for their previous ‘losses’. Nevertheless, this highly contro-

versial yet counterintuitive policy has been partially successful in

Dubai because of strict enforcement, and because tenants are provided

greater choices as the supply of housing expands in the medium term.

Price controls have been only partially successful because of major

loopholes such as the possibility of landlords evicting ‘old’ tenants on

the pretext that they will be renovating their premises, and due to the

large volume of complaints which cannot be always handled by the

courts on a timely basis.

Against this background on the rising cost-of-living in Dubai,

the government has considered several other options to control prices.

One option would be to fix the exchange rate to a basket of currencies

with different weights according to its different trade volumes with the

rest of the world. For example, given the relatively large share of im-

ports from euro zone countries, a greater weight would be attached to

the Euro compared to the US dollar. This would cushion the inflation-

ary effects of a fall in the US dollar as the relative price of imports from

euro zone countries will not be affected by as much as under the current

fixed exchange rate system. For a more direct and policy oriented solu-

tion, the government could adopt inflation targeting which is character-

77 For example, after the imposition of the $4.35 cap on the price of cement, most pro-ducers began selling it at $6 on the black market.

92


ized by an announced numerical inflation target, an implementation of

monetary policy that gives a major role to an inflation forecast, and a

high degree of transparency and accountability78.

The recent global financial crisis has considerably reduced the

cost-of-living in Dubai. A government report on month-by-month eco-

nomic data shows the lowest rate of inflation in nearly a decade. Since

the beginning of 2009, the rate of inflation has slowed to just 1.9%

(from 7.2%) as reported by the UAE Ministry of Economy. This fall in

the rate of inflation is explained by the fall in housing and utility costs

(which make up 40% of the basket of goods an services used in the cal-

culation of the Consumer Price Index), and decreases in the price of in-

termediate inputs such as steel and cement. The price of steel has fallen

by almost 70%, and cement prices have fallen by an average of 22% in

2009. Moreover, the Ministry of Economy has signed several Memo-

randa of Understanding with large retailers and cooperative societies to

fix the price of basic food items. Annual inflation in January of 2009

stood at 7.2%, slowing to 6.2% in February, 4.5% in March, and 1.9%

in April according to the latest figures published by the Ministry of

Economy. In 2008, the average rate of inflation was 12.3%, peaking at

13.5% in the second quarter of the same year. Due to this fall in the

price level, some economists are predicting a deflation which could

have severe negative repercussions on the domestic economy79. How-

78 See Blum and Durlauf (2007) for a more detailed definition of inflation targeting. 79 The main problem with deflation is that people in debt (a large number of people during a recession) will be worse-off. When someone has borrowed $1,000 from a bank, a 10% annual deflation rate will increase the burden of the loan by 10% - i.e. the borrower has to pay back $1,100 in a year’s time. Conversely, when the rate of in-flation is 10% annually, then the burden of the loan will be only $900 since the pur-

93


ever, given the expansionary fiscal policies in the form increased gov-

ernment expenditure to finance the rapid development of the Dubai

economy, it is highly unlikely that the Dubai economy will fall in a de-

flationary trap.

chasing power of the dollar has decreased by 10%.

94


Some Labor Issues

As outlined in the Dubai Strategic Plan (2015), to achieve its

ambitious targets of generating an annual average GDP growth rate of

11%, Dubai requires an additional 880,000 workers by 2015. The bulk

of these workers, about 70%, will be in the construction and related ser-

vice sectors which would add to existing labor problems especially in

the unskilled segment of the labor force. Currently, there are approxi-

mately 500,000 unskilled workers in Dubai, mainly from Southeast

Asian countries (India and Pakistan) which constitute close to 50% of

the labor force80. These workers earn a net monthly income of between

$150 and $250 and live in labor accommodations in designated areas.

Recent labor unrests and disputes have increased the profile of these

workers, and the government has taken serious steps to improve their

working conditions. These labor protests have been primarily caused by

the fall in workers’ real wages due to the fall in the US dollar and rising

rates of inflation which have reduced their purchasing power and their

ability to remit a large chunk of their incomes to their families in their

home countries. Another source of tension has been caused by the ille-

gal actions of labor recruiting agencies which charge unskilled workers

for work visas and related costs, a practice illegal under UAE labor

laws. Non-payment of wages on a timely basis by construction compa-

nies has also been a major source of tension in recent months.

Having realized these problems, the government has begun to

take serious steps to improve working conditions and act as an enforcer

80 Statistical Yearbook – Emirate of Dubai (2007). See Table 03-02, pp 91-92.

95


of existing labor laws and regulations. Tens of thousands of unskilled

workers have taken advantage of a summer-long amnesty in 2007 for

illegal workers agreeing to either legalize their residence status or leave

the country. In recent interviews, officials at the ministries of economy

and labor have said that there is no sign of an impending labor short-

age. Plenty of workers are eager to enter the country to take the place of

leaving workers. In addition, regulators have enforced midday sun

breaks, improved health benefits, upgraded living conditions, and

cracked down on employers bold enough to stop paying workers at all.

To this end, the Ministry of Labor has just launched a Salary Protection

System to ensure that workers receive their wages on time by requiring

all companies in to transfer worker salaries to personal bank accounts.

In a break with past practices, the Ministry of Labor has been backing

the demand of the workers. In cases where companies are not able to

pay wages, the Ministry has tapped company bank guarantees to pay

back wages. It has also barred some companies from hiring additional

workers which has led them to close their Dubai operations, and has

helped existing workers find new jobs. At the GITEX 2008 exhibition

recently, a mobile-phone service was launched to meet the financial

needs of low-income workers. The service, called “Alo”, is a pay-as-

you-go mobile service which has been designed to suit the needs of un-

skilled workers. Workers will not have to pay subscription fees but

only a monthly installment fee of less than $2. The service, apart from

the normal mobile package, will inform workers about changes in labor

laws, provide labor news and other labor related information, and will

enable easy communication between workers and the government.

96


Moreover, in a highly innovative initiative, Etisalat, the local telecom-

munications company, will soon enable laborers to send remittances to

their home countries through their mobile phones using a system called

mPay. This will greatly ease the burden of unskilled workers by avoid-

ing the high transfer fees paid to traditional money remittance compa-

nies and exchanges.

Other initiatives include the proposed establishment of an

agency directly under government supervision to stop the practice of la-

bor agencies to charge illegal work visa fees. Currently, most labor

agencies recruiting workers from Southeast Asia openly charge the men

and women they bring to the country the ‘cost’ of their visas which is

illegal under UAE labor laws. Due to this practice, many workers have

to take out loans of more than $2,000, often at high interest rates. As a

consequence of this practice, a construction worker uses a chunk of his

monthly wages towards the repayment of the loan, forcing him into a

cycle of debt. Since this illegal practice emanates in the workers’ home

countries prior to the worker’s arrival in Dubai, the government has

signed several agreements with labor exporting countries to prevent

such practices and set minimum wages and standards which has consid-

erably improved working conditions and wages. Moreover, the rela-

tively low wages that these unskilled workers receive in their home

countries is still a big incentive for them to migrate to Dubai even un-

der the assumption that Southeast Asian economies, especially India

and Pakistan, have experienced recent economic boom. This is because

most of the new jobs created in these countries are more suited for

skilled and semi-skilled workers. The government has also been con-

97


sidering shutting down the labor agencies that recruit construction

workers and build ‘worker cities’ to replace about 170 labor agencies

currently licensed by the Ministry of Labor.

The government realizes the importance of labor issues and has

taken many concrete steps, as outlined above, to improve their working

conditions. In the words of one official, “a happy worker is a more pro-

ductive worker”. This is especially true of unskilled workers in the con-

struction sector who are building the infrastructure of a rapidly growing

economy to meet the ambitious targets of the Dubai Strategic Plan

(2015). However, the boom in the real estate market will gradually

slow down in the coming few years as many projects have been de-

layed or put on-hold, in turn reducing the profitability of the real estate

sector to ‘normal’ levels. Nevertheless, given the speed at which real

estate projects are completed in Dubai and the slowdown in the global

economy, there will always be labor disputes to tackle, just as in any

other market type economy.

98


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Draft 09 the Secret of Dubai's Long-Run Economic Success Counter Intuition