PAGE: IMPACT OF OIL PRICES ON GULF STATES

THE IMPACT OF LOWER OIL PRICES ON THE ECONOMIES OF GULF STATES

John Page

Mr. Page is the chief economist and director of the Middle East and North AJiica Social and Economic Development Group at the World Bank. The following is the edited text of his remarks to a Brookings Sadat Forum on April 21, 1999, at the Brookings Institution. The cosponsors are the Brookings Foreign Policy Program and the Anwar Sadat Chair for Peace and Development at the University of Maryland.

will address two sets of issues today: first, the extent to which oil dependence remains an important I factor in the Middle East; and

second, the extent to which, at least on the basis of our projections, a 20-percent reduction in the price of oil from the consensus forecasts of 1997 ($19-$16 a barrel) will affect the oil-producing economies. But I also would like to make a point that is very dramatically shown in Figure 1. There are really only two kinds of economies in the Middle East: oil economies and non-oil economies. The reason is that, when we customarily think of economic integration in terms of trade flows, the Middle East is one of the most integrated regions in the world in terms of the flows of labor and capital. Capital tends to move from the capital-surplus, oil-producing economies to the capital- deficit developing economies of the region. Labor flows from the labor- surplus developing economies of the region to the oil-surplus, labor-importing

economies of the Gulf. So, when Saudi Arabia gets a cold, Egypt sneezes.

Figure 1 shows both the share of oil revenue in GDP and the share of remittances in GDP. We would conventionally expect countries like Kuwait, Oman and Qatar to be oil- dependent. But Jordan, Lebanon and, dramatically, Yemen are highly oil- dependent. In fact, when you combine the sum of remittances and oil revenues in Yemen, you get to a rather spectacular number, somewhere in the range of about 60 percent of GDP. So the economic changes taking place in the Gulf will not only affect the Gulf economies themselves but, via the attitudes of investors and particularly of employers, the fortunes of Mashreq economies in general.

Figure 2 shows again the extent of dependence on exports of a number of the oil producers. The share of oil in exports ranges anywhere from almost 90 percent for Algeria - another case that deserves attention, if you believe that-political

59

~

MIDDLE EAST POLICY, VOL. VI, No. 4, JUNE 1999

vulnerability in that society is responsive to changes in income - to Tunisia and Egypt, where oil is no longer a particularly important source of foreign exchange and revenues.

Government revenues tell a similar story (Figure 3). Generally speaking, oil’s share of government revenue in the oil exporters of the Gulf is on the order of 60- 70 percent. In Kuwait it’s about 80 percent. In Algeria and Yemen it’s also a very high proportion of government revenue. When oil is both a high proportion of exports and a high proportion of government revenues and the price of oil changes, governments find themselves in a dual dilemma. Fiscal pressures increase: expenditures are unable to change quickly, and, of course, a reduction in foreign exchange earnings puts pressure on the current account of the balance of payments. I t is important to keep in mind that for most of these economies fixed exchange rates are the order of the day. So the adjustment has to take place in domestic consumption, because expenditure-switching techniques - changing the exchange rate to deal with the terms-of-trade shock - is, at least in the short run, not in the cards.

We can put all that together and come to a set of projections about the impact of the oil-price change on income growth. The difference between gross domestic income and gross domestic product is quite dramatic in oil exporters, due to the terms-of-trade effect - increases in absorption when the price is high and decreases in absorption when the price is low, relative to national production. Let me give you an example. In 1996, the rate of growth of the Saudi economy was on the order of about 1.82 percent. The rate

of growth of gross national income adjusted by the terms of trade was in excess of 6.5 percent. So in terms of the welfare of the Saudi consumer, the same set of economic circumstances gave a rate of growth almost triple that of national output. Let us keep in mind that on the upside there is a great benefit to this, but on the downside there is a large compression of income and welfare. So the volatility of income and the perception of the average citizen that things are changing very rapidly are amplified by the difference between national income and national output.

What you can see here is a fairly dismal story (Figure 4), one that reflects the economic history of the region. The Middle East is striking in that from 1960 to 1985, in terms of national income growth per capita, it outperformed all of the regions of the developing world with the exception of East Asia and the Pacific. Between 1985 and I995 it underperformed all other regions of the developing world with the exception of sub-Saharan Africa. The swing from growth in per capita income to compression in per capita income is the largest anywhere in the developing world. That, of course, is one of the underlying explanations for the profound sense that the man on the Arab street has that the good times are gone and not much is coming to bring them back. Within the 1 0-year span of memory of the average Jordanian, per capita national income has fallen by nearly 30 percent, recovered now by 5 percent, leaving them 25-percent less well-off than they were in 1989.

For the oil states, with the exception of Kuwait, per capita income performance was anemic 1985-95 (Figure 4). Before

60

PAGE: IMPACT OF OIL PRICES ON GULF STATES

this hypothetical oil-price change of $3 a barrel, we were already predicting negative per capita income growth, except in the Emirates. We now predict even more negative per capita income growth, somewhere on the order of 3-4 percent across the region, with none of the Gulf economies showing positive income growth in the period. That is both a function of low overall economic growth rates and very high population growth.

In the developing countries of the region, we were projecting something of a fragile recovery. The particular superstars in this story by regional standards, Egypt and Tunisia, are projected to lose 2-2.5 percentage points of economic growth as a consequence of the oil-price change, notwithstanding the fact that they are minor producers. The growth decline comes through reduced flows of investment and remittances, as well as tourism and trade. The inter- connectedness of the Arab region really begins to play itself out in these scenarios.

The impact on current-account balances is similarly unsettling (Figure S ) , although the Kuwaitis will continue to run a very substantial surplus. Saudi Arabia, which had been running a modest current- account surplus, is now in a situation where these projections suggest a deficit of about 9 percent of GDP. Current- account balances that had dropped to zero for the rest of the region should move into the moderately negative range. After the oil-price shock, we are predicting fairly dramatic increases in fiscal deficits, most notably in Kuwait, Saudi Arabia and Qatar (Figure 6 ) . For the other economies in the region, the range of 4-5 percent is a reasonable fiscal balance, depending on whether there is recourse to non-

inflationary finance. I would not even be so bold as to argue that it will result in major episodes of macroeconomic instability later in the GCC. I n Kuwait, because 10 percent of all oil revenues are fed right off the top into the fund for future generations, there is a substantial pool of public-sector savings. This introduces an interesting choice for Kuwaiti policymakers: to try to ride this out by borrowing from the fund in order to sustain levels of consumption and employment in the public sector or to recognize that this may be a permanent change and therefore begin a process of adjustment. That discussion is taking place in Kuwait right now, and there are as many opinions as there are elements in Kuwaiti society.

Kuwait’s dilemma underlies a key issue for oil-producing economies, something found through all of the countries of the Gulf. Every time a decision to produce is made, or every time a decision to use assets that have accumulated as a result of past production is made, future generations are being taxed for the benefit of the current one. This is a relatively easy thing for politicians to do, but it causes societies (and economists) to lose sleep.

I t is also the case, of course, that if you sit on a very large asset, you can become easily indebted. That is another way of smoothing consumption. As you can see, we predict that the national external debt ratios, which are very moderate in the Gulf but alarming in places like Algeria, Yemen and Tunisia, are likely to increase moderately as governments move into using debt financing as a means for dealing with projected increases in fiscal deficits.

61

MIDDLE EAST POLICY, VOL. VI, No. 4, JUNE 1999

The debt story can have two different sets of consequences. If governments report international debt, you worry about vulnerability. If it's domestic debt, you worry about the crowding out of the private sector. For example, the level of private-sector savings in Saudi Arabia is about 4 percentage points above the level of investment. The level of public-sector savings is now 4-6 percent.

I would like to relate this economic gloom and doom to the social picture in the region. If I could post any slogan in the office of a minister of economy or planning or finance in the Arab world, I would say, "It's about jobs, Your Excellency." The challenge that all Arab governments face today is one of addressing rising unemployment, particularly unemployment of the young and the better educated. This is true everywhere from Morocco to Iran. It has different manifestations in different economies, but if you look at the unemployment rates in Figure 7, you will find that they are nothing short of horrific. These would even be a cause of concern for European economies, which have a relatively high tolerance for unemployment. This involuntary unemployment leads to social pressures as a consequence of the lack of jobs for college and secondary-school graduates.

The response of countries in the region for the last 30 years has been to use the public sector to deal with the employment challenge, to be the employer of first resort. The shares of public-sector employment, particularly in the Gulf states, are extremely large, as are the shares of wages to oil revenues (Figure 8). Fiscal pressures arising from any sustained, relatively low oil price -

whether $19 or $16 a barrel - are going to limit the ability of the state to deliver new employment places to the next generation. This is exacerbated by the fact that, as a consequence of the demographic bubble, labor-force growth rates, particularly of nationals in the Gulf, are increasing very rapidly. The public sector can no longer deliver employment places, and the labor force is growing and better educated.

Figure 9 shows the required rate of growth of national income. This would absorb the labor-force increase and maintain unemployment at current rates. Since these unemployment rates are unacceptably high, this is a very modest goal. The figure presents two scenarios: the oil price at $19 and $16. The required rates of growth are really quite high compared to the economic performance of the region over the last 15 years, ranging from 5-10 percent. Once you factor in the oil-price decline, the projected GDP growth rate only exceeds the required growth rate in Egypt and Tunisia. In Kuwait, Saudi Arabia and Oman, there is an extremely serious problem of catch-up. That will increase pressures for indigenization - Saudization, Kuwaitization, Omanization - of the labor force. It is quite revealing that the Six- year Plan in Saudi Arabia projects that all of the net employment creation in the Saudi economy to take place during the period 1995-2000 will occur as a consequence of the substitution of Saudi workers for non-nationals. There was no concept of net employment growth in the Saudi economy beyond employment substitution.

In summary, issues faced by three of the big economies of the Gulf - Kuwait, Oman and Saudi Arabia - coalesce

62

PAGE: IMPACT OF OIL PRICES ON GULF STATES

around three things: first, the need for fiscal adjustment. All of these governments are aware of this, but they find it difficult to confront because of the rent-sharing nature of their societies and the fact that public employment has always been the means by which oil rents are shared out to the people. They now confront the possibility of having to separate the issue of employment from the issue of entitlement. In fact, one hears some debate in Kuwait and Oman on the idea of voucher schemes or other mechanisms that will entitle nationals to share the petroleum rents while separating wages from the petroleum question and

making them more responsive to changes in productivity and conditions in the private labor market. Second, all these economies face the need to create a vibrant and sustainable private sector, because the issue of economic diversification remains very much on the table. In many ways, the environment remains tough for the private sector. Finally, there is the need to find better mechanisms to smooth the boom and bust cycles that have come into play with oil prices moving so radically in the last 30 years. Clearly, economics is not called the dismal science for nothing.

Sources: 1-6 - MNA Live Database, IMF Article IV Report (2/24/99); 7 & 9 - World Bank Estimates

Figure 1: Share of Oil & Share of Remittances in GDP (1997) note: Kuwait data from latest available year

45

40

35

30

25

20

15

10

5

0 C

.c m

.- E m

m v)

63

Figure 2: 1997 Share of Oil in Exports note: Exports of goods and services

8 0 .

7 0 .

6 0 .

5 0 .

40.

30. 20 -

10.

0 -

Figure 3: Oil Revenue as a Share of Government Revenue (1997)

Bahrain

Kuwait

Oman

Qatar

Saudi Arabia

UAE

Algeria

Iran

Syria

Tunisia

Yemen

0 20 80 100

Figure 4: GDP per captia Growth - 1985-1995 and 1996-2000 (before and after a 20-percent fall in oil prices for M N A exporters)

note: Illustrative first-round effects based on 1997 benchmark values

6

4

2

0

-2

-4

-6

5 3 d cn

Figure 5: Current-Account Balance (before and after a 20-percent fall in oil prices for MNA exporters)

notes: Current-account balance to GDP ratio (percent). Illustrative first-round effects based on 1997 benchmark values

-10 +-- I

I -40

Figure 6: Fiscal Balance (before and after a 20-percent fall in oil prices for MNA exporters)

notes: Fiscal balance to GDP ratio (percent). Illustrative first-round effects based on 1997 benchmark values

Figure 7: Unemployment Rate in the Region note: Latest available year. Rate for Kuwait and Oman for nationals, only

- 1

I 1

Tunisia 15.60%

Kuwait 1.30%

1 - - 1 -- - 7-- - - - 0.0% 5.0% 10.0% 45.0% 20.0% 25.0% 30.0%

Figure 8: Public-Sector Employment & Government Wages and Salaries

1 2 0 n 1

I 0 0

ao

60

40

20

0 Bahrain Kuwait Oman Qatar Saudi UAE

Arabia

Figure 9: Required Real GDP Growth to Maintain Existing Unemployment & GDP Growth after a 20-percent Decline in Oil Prices (1996-2000)