محاضرات | Lectures

Justice, Curse, and Spring : The Current Predicament in the GCC

Dr. Mohammad Sabah Al-Salem Al-Sabah's lectured titled "Justice, Curse, and Spring : The Current Predicament in the GCC" at the London School of Economics

June 15, 2012

 

 

It has been said that economists look at theory  and wonder if it works in real life. Equally true, economists look at things working in real life and wonder if it work in theory!

 

Although, the concept of " sustainable development" have been widely used by economists, politicians, environmentalists etc, yet there are more than 300 different definition of the concept " sustainability ". Dobson(96)

Fiscal sustainability is an indicator set to answer the following question:

Is the current or planned primary fiscal balances are compatible with stable debt to GDP ratios given interest rate, growth rate, and real exchange rate?

In another word, will the current fiscal policy enable the country to pay back it's debt Or drive it into bankruptcy ? Greece Dubai

However, the debate over fiscal rules and fiscal sustainability in presence of exhaustible resources, takes fundamentally different tune. The debate is heavenly influenced by concerns that transcends the solvency issues to include moral and ethical ones.

 

The economic challenges that confront policy makers in exhaustible resource economy (ERE) are multidimensional. Finding solutions to these challenges are difficult process, with agonizing decisions and painful trade offs.  The simple fact about the nature of the resource in these economies, is that it is extremely volatile, highly uncertain, and definitely exhaustible.

 

I- Exhaustibility. eg Nauru

The holly grail of policy makers in ERE is to find a set of fiscal rules that would maximize the inter temporal welfare of society subject to the Exhaustibility constraint. By solving this problem we get the optimal rate of depletion that will assure inter generational equity and fiscal sustainability.

In his famous article " inter generational equity and the investing of rent from exhaustible resource" Hartwick (77) showed that a sustainable fiscal policy is the one that converts a temporary exhaustible stock of natural resource into a stock of financial assets that generate a permanent income stream.

Inter generational equity calls for the current generation to pursue a fiscal policy that allows the accumulation of financial assets. The return on those assets, in turn, can finance the sustainable deficit, once the country's resource reserves has been exhausted. In other words, the rate of depletion should be treated as a portfolio transaction, whereby resource wealth is transformed into financial wealth.

 

II- Volatility, Uncertainty and Dutch Disease.

The question here is : how to design and implement a fiscal policy that will minimize the harmfully effect of resource price volatility, and immune the economy from the symptoms of the Dutch Disease?

Fiscal policy can sterilize the resource booms by transferring all the resource rent into off balance sheet fund ie resource fund. The advantage of this fund is that it can limit DD symptoms by insulating the economy from the volatility of the resource windfall. This fund can also play a macroeconomic stabilizing role through counter cyclical measures, and also be a saving fund for future generations.

Norwegian rule: bird in the hand, is to spend the return on resource fund

Kuwait rule: it's allocation rule rather than spending rule

 

III- Resource Curse.

The important work of Gelb(88), Auty(90), Sachs and Warner(95), have created an increasing appreciation for the impact of natural resource endowment on the pattern of economic growth and development. Sachs and Warner in particular have shown that resource poor countries often vastly outperform resource rich economies in economic growth. They estimated that a 15% increase in the ratio of natural resource export to GDP Reduce predicted growth by over a one percentage point per year. And the debate is still raging over WHY?

It has often been thought, that the seductive nature of the natural resource rent, has the tendency to distort government behavior. During a resource boom, resource rent flows freely with ease into government budget. Large windfalls entice government to pursue political profiteering and play the game of " politics without limits'.

In here book " Paradox of Plenty ", Terry Karl(97) linked resource abundance to corruption, authoritarianism, and economic decline. While Collier etal(05), attributed violent conflicts and civil wars in Africa to the overwhelming resource dependence in those countries.

So is the resource rich countries doomed for ever?  Not so said Bhattacharyya and Hadler(09). They studied 124 countries over the period 1980-2004. They found that the relationship between natural resource abundance and corruption depend on the quality of the democratic institutions. The lack of transparency, accountability, strong system of checks and balances in the governance process, is a major reason behind the widespread corruption in resource rich countries.

So given the moral imperative of inter generational equity, the economic concerns about macro stability and DD, and the sociopolitical fear of the resource curse, one would expect the GCC countries to follow a conservative fiscal policy. And then came the Arab spring !,

 

IV- Arab Spring and GCC.

GCC is extremely long in the hydrocarbon assets, and highly dependent on it. 37% of the world proven oil reserve and 22% of the world proven gas are located in GCC. Kuwait, Qatar, and UAE have more than 100, and saudi arabia has 75 years of oil & gas production at current extraction rate. While Bahrain and Oman are expected to exhaust their reserves in the next 2 decades.

As of 2011, Qatar's per capita reserves 770,000 barrel of oil equivalent followed by UAE and Kuwait at 142,000 $ 96,000 boe respectively. Saudi Arabia, Oman, and Bahrain's per capita reserves are 16000, 5000, 3000 respectively.

Furthermore, the GCC is extremely dependent on the hydrocarbon sector as a source of foreign exchange. Over the period 2000-2010, oil & gas accounted for 35% of the region's GDP, and generated 77% of the total foreign exchange earnings. To be sure, the GCC government rely almost exclusively on this sector for budgetary financing. On average, the hydrocarbon sector provided almost 80% of the GCC government revenues during the period 2006-2010.

It is interesting to note that Kuwait stands out as the most oil dependent country in the GCC. Over the period 2006-2010, the oil sector in Kuwait generated 95% of government revenues, and 93% of exports. These facts make Kuwait the most vulnerable to Dutch Disease and Resource Curse phenomena.

Even with respect to the government budget composition, Kuwait appear to follow a consumption oriented fiscal policy relative to other GCC. Over the period 2000-2009, 88% of Kuwait total government expenditure Was on current expenditures. While the corresponding ratios in the GCC are UAE 83%, Saudi Arabia 80%, Bahrain 76%, Oman 72%, and Qatar 70%.

More disturbing is the dominance of government position in the non oil economy. Again, Kuwaiti government has an overwhelming presence in domestic non oil economic activities that is unparalleled in other GCC. For the period 2000-2009, Kuwait government expenditure represented almost 80% of the non oil GDP. The closest in the GCC were Oman and Saudi Arabia with 66% , UAE and Bahrain with 36%, and Qatar with 64%.

The Arab spring has exacerbated the fiscal imbalances in the GCC. The Arab spring, to be sure, forced GCC government to undertake populist measures and polices. Government spending increased by almost 20% in 2011, from $300 billion in 2010 to $360 billion in 2011. Most of spending was for job creation, wages, housing and other social programs.

The ILO report indicated that the youth unemployment in the GCC in 2009 was nearly double the global rate of 12.8%. A fact that might explain the surge in public spending on job creation.

 

Some of the examples of Arab spring related expenditures in GCC :

Bahrain: in face of serious sectarian division, the Government pledged $6.6 billion in new housing construction.

UAE: new food subsidies were introduced, increase in government pensions by 70%, a pledge of $2 billion in housing loans in the northern states. Independently, government of Abu dhabi allocated $600 million of housing loans to its citizens.

Saudi Arabia: a package of $130 billion was announced in 2011 to combat youth unemployment and other social issues.

Oman: government pledge of $1.3 billion in new social benefits plus the creation of 50,000 new jobs in public sector.

Qatar: government pledge $8.1 billion social services, including a big increase in general salaries.

Kuwait: government spending jumbled from $40 billion in 2009/2010 to $57 billion in 2010/2011, to expected $69 billion 2011/2012, ie an average increase of 31.5% per year.

Rising commitments of GCC governments will certainly put more pressure    and introduce more rigidities in public finances. Despite the current positive financial position, these expenditure programs will prove to be unsustainable.

The continuing turmoil in global financial markets, the euro crisis, and the possible contagion to Asian markets suggest a considerable downside risk to oil prices. As risk aversion rises globally, capital inflows to GCC may also slowdown, and earning on GCC external assets might decline.

The world bank predicted a 3.4% decline in oil prices in 2013 and anther half percent drop in 2014.

Hence, the combination of both rising public expenditures and declining or softening oil prices will certainly face the GCC with a serious financial challenges. The budget break even prices have risen substantially in recent years, and it will continue to rise if these trends continue.

In a recent study by Kuwait national competitiveness committee(2012), they predicted that without constraining public spending, Kuwait will face serious budget deficit in less than 10 years, even under optimistic oil price scenario.

This finding was confirmed by recent IMF study. The IMF warned Kuwait of a looming budget deficit if it doesn't cut spending by at least $25 billion by 2017.

To be sure, in his letter of resignation few months ago, the former governor of the central bank of Kuwait Salim A. AlSabah described the current economic scene as a run away fiscal policy with unprecedented financial chaos. He emphasized that time is running out, Kuwait need to use its temporary financial surplus to affect economic reform rather than avoid it.

Furthermore, the minister of finance confirmed in a statement before parliament, few weeks ago, that 73% of oil revenues are spent on wages & salaries. He estimated Kuwait break even price to be no less than $107.  And if the current trends of public spending continued , then, he estimate, the break even to be $213.

 

In short, the current fiscal policy is unsustainable. Government and parliament must work together to reverse the current dangerous trends. Failing to do so now, will have dire consequences on the social and economic fabric of society. The integrity of Kuwait financial system should be preserved and the welfare of Kuwait's future generations must be protected.