June 18, 2012
Dr. Mohammad AlSabah, former Minister of Foreign Affairs, considered the current financial policy unsustainable and urged during a lecture at the London School of Economics and Political Science for cooperation between the council and government to halt dangerous financial spending trends. He warned that failure by both authorities to do so would entail serious repercussions on society. He emphasized the necessity of maintaining Kuwait's financial system's integrity and protecting the welfare of future generations.
Dr. Mohammad AlSabah primarily discussed the contradiction between the concept of sustainable development in the Gulf Cooperation Council countries and depleting resources. He argued that Kuwait pursues a wealth distribution policy, relying primarily on 95% oil resources, making it most susceptible to the Dutch disease and the resource curse phenomenon.
Here is the text of Dr. Mohammad AlSabah's lecture:
"It was said long ago that economists return to theory and wonder if it will succeed in real life, and likewise, economists look at successful things in practical life and wonder if they are theoretically correct!
Despite the widespread use of the term 'sustainable development' by economic experts, politicians, and environmentalists, etc., there are more than three hundred different definitions for this term.
Financial sustainability is an indicator of answering the following question: Are current or planned financial budgets compatible with stable debt compared to general GDP rates under interest rates, growth rates, and real exchange rates? In other words, can current financial policies enable the country to pay off its debts, or will they lead it to bankruptcy?
The debate over financial rules and financial sustainability has taken a completely different turn in the face of depleting resources. This debate goes beyond the issue of bankruptcy to moral and ethical issues.
The challenges facing decision-makers in resource-depleted economies have multiple dimensions, and finding a solution to these challenges is a difficult process that requires tough decisions and painful trade-offs. The simple truth regarding the nature of resources in these economies is that they are highly volatile, uncertain, and prone to depletion.
1. Vulnerability to depletion:
The holy grail for decision-makers in resource-depleted economies is finding financial rules that will maximize the welfare of vulnerable societies by leading the resources to maximum possible depletion. Solving this problem ensures the optimal rate of depletion that confirms intergenerational equality and financial sustainability.
Hartwick explained in his famous article titled 'Intergenerational Equity and Investment in Depleted Resource Rents... Sustainable fiscal policy is one that can convert a temporary, depletable stock of natural resources into a stock of financial assets that yields a permanent income source.
Inter-generational equality requires the current generation to adopt a financial policy that allows for the accumulation of financial assets. Thus, the return on these assets can finance the sustainable deficit when the country's resources are depleted, meaning that the depletion rate must be treated as a financial portfolio that converts wealth resources into financial wealth.
2. Volatility, Uncertainty, and the Dutch Disease:
The question here is how to draw and implement a financial policy that minimizes the harmful effects of resource price fluctuations and immunizes the economy against the symptoms of the Dutch disease?
Financial policy can immunize prosperity in resources by turning all resource returns into a resource fund. The advantage of this fund is that it can mitigate the symptoms of the Dutch disease by immunizing the economy and resource price fluctuations. Such a fund can also play a role in stabilizing the economy through periodic countermeasures, as well as assuming the role of a savings fund for future generations, as the Norwegian rule goes into spending returns on a resource fund. The Kuwaiti rule is that the focus should be on distribution rules rather than spending rules.
3. Resource Curse:
The important works of Gelb (1988), Auty (1990), and Sachs and Warner (1995) found an increasing estimation of the impact of natural resource abundance on economic growth and development. Sachs and Warner, in particular, found that resource-poor countries outperformed resource-rich countries in economic growth.
They estimated that a 15% increase in the natural resource rate to the GDP rate reduced expected growth by more than 1% annually, and the debate continues about the reasons.
There has always been a belief that the enticing nature of natural resource returns often corrupts government behavior. During resource prosperity, returns flowed easily into state budgets. The significant drop in prices, on the other hand, tempted the government to seek political gain and play 'policy without limits'.
In her book titled 'The Paradox of Plenty,' Terry Karl linked resource abundance to corruption, authoritarianism, and economic decline. Meanwhile, Collier and Haddad attributed violent conflicts and civil wars to excessive reliance on these resources in those countries.
Will resource-rich countries remain so forever? Patacchari and Haddler (2009) say not, as they studied 124 countries during the period from 1980 to 2004 and found that the relationship between resource abundance and corruption depends on the quality of democratic institutions. The absence of transparency, credibility, control systems, and balance in governance institutions are all major reasons for the spread of corruption in resource-rich countries.
Thus, considering the ethical duty of intergenerational equality, and in light of economic concerns about stability, the Dutch disease, and social and political concerns about the resource curse, one would expect Gulf Cooperation Council countries to adopt a conservative financial policy... then came the Arab Spring.
4. The Arab Spring and the Gulf States:
The Gulf Cooperation Council countries possess a vast and long-term reserve of hydrocarbon resources that they heavily rely on. They hold 37% of the world's oil reserves and 22% of natural gas reserves. It is expected that Kuwait, Qatar, and the United Arab Emirates' oil and gas production will extend to a hundred years, and Saudi Arabia to seventy-five years, according to current production levels, while Bahrain and Oman are expected to exhaust their reserves in the next two decades.
From 2011 onwards, Qatar's reserves exceeded 770,000 barrels of oil per capita, 142,000 in the UAE, 96,000 in Kuwait, 16,000 in Saudi Arabia, 5,000 in Oman, and 3,000 in Bahrain.
Moreover, the Gulf countries rely heavily on the oil sector as a source of foreign currency. During the period from 2010 to 2000, oil and gas constituted 35% of the total GDP of these countries, and produced 77% of the total foreign currency returns. The governments of the Gulf Cooperation Council countries specifically rely on this sector to finance their budgets. The hydrocarbon sector represented about 80% of the governments' returns in the Gulf Cooperation Council countries during that period."
The most vulnerable
Of note is that Kuwait is the most reliant on oil among all GCC countries, as during the period from 2006 to 2010, oil constituted about 95% of government revenues and 93% of exports. These facts make Kuwait the most susceptible to the Dutch disease and the resource curse phenomenon.
Even concerning budget structures, it seems that Kuwait follows a more consumption-oriented fiscal policy compared to other GCC countries. During the period from 2000 to 2009, current expenditures accounted for more than 88% of government expenditures, while this percentage reached 83% in the UAE, 80% in Saudi Arabia, 76% in Bahrain, 72% in Oman, and 70% in Qatar.
More worrisome is the government's dominance over non-oil sectors of the economy. Once again, the government records a dominant presence in non-oil economic activities, unlike any other GCC country.
Government spending in Kuwait during the period from 2000 to 2009 reached about 80% of non-oil GDP. The closest countries to Kuwait in this regard were Oman and Saudi Arabia (66%), the UAE and Bahrain (36%), and Qatar (64%).
Financial Stability Undermined
The Arab Spring has accelerated the destabilization of the financial stability of GCC countries, forcing the governments of these countries to take populist steps and policies. Government spending increased by 20% in 2011 from $300 billion in 2010 to $360 billion in 2011. Most of this expenditure went towards creating job opportunities, increasing wages, housing, and other social programs.
The International Labor Organization noted in its report that the unemployment rate in GCC countries in 2009 reached twice the global average (12.8%). In fact, this may explain the focus on public spending on creating new job opportunities.
Increasing Commitments of GCC Countries
It is certain that the governments of these countries will face more pressure and implement stricter measures in public spending. Despite the current positive financial position, spending programs cannot continue.
The ongoing disruptions in global financial markets, the euro crisis, and the possibility of contagion to global markets highlight the risks of potential declines in oil prices. With global risk ranges consistent, capital flows to the Gulf countries may also decline, and GCC countries' revenues from foreign assets may decrease. The World Bank predicted a 3.4% decline in oil prices in 2013 and another 0.5% decline in 2014.
Therefore, the convergence of increased public spending and declining oil prices will pose serious challenges to the governments of GCC countries. On the other hand, the breakeven price for the budget has increased significantly in recent years and will continue to rise if current market trends persist.
In a recent study conducted by the National Competitiveness Committee in Kuwait (2012), the study's organizers predicted that Kuwait would face a serious budget deficit in less than ten years, even under the most optimistic scenarios for future oil prices if public spending is not controlled.
A recent study by the International Monetary Fund reaffirmed what the Kuwaiti committee had concluded. The IMF warned Kuwait of a looming budget deficit if public spending is not reduced by $25 billion by 2017. To be fair, former Central Bank Governor Salem Abdul Aziz AlSabah described in his resignation letter the current economic situation as heading towards unprecedented financial chaos. He affirmed that time is passing quickly, and Kuwait needs to use its current financial surpluses to carry out economic reforms rather than evade them.
Additionally, the Minister of Finance, in a statement before the National Assembly weeks ago, estimated that the government spends 73% of oil revenues on salaries and wages. He estimated that the breakeven price for Kuwait's budget would be less than $107, and if the trend of public spending continues, the breakeven price, according to the minister's estimates, will reach $213.
In summary, current fiscal policy cannot continue, and the government and National Assembly must work together to halt dangerous public spending trends. If they fail to do so now, there will be serious repercussions on the social and economic fabric of society. It is necessary to maintain Kuwait's financial system's integrity and protect the welfare of future generations.
Financial Chaos
Dr. Mohammad AlSabah also referred to the resignation letter of former Central Bank Governor Salem Abdul Aziz AlSabah, describing the current economic scene as heading towards unprecedented financial chaos.
Ethical Duty
Dr. Mohammad AlSabah stated that considering the ethical duty of intergenerational equality, and in light of economic concerns about stability, the Dutch disease, and social and political concerns about the resource curse, one would expect GCC countries to adopt a conservative financial policy... then came the Arab Spring.
Serious Deficit
Dr. Mohammad AlSabah relied on a recent study conducted by the National Competitiveness Committee in Kuwait in 2012, predicting that Kuwait would face a serious budget deficit in less than ten years, even under the most optimistic scenarios for future oil prices if public spending is not controlled.
Expenses Related to the Arab Spring
Dr. Mohammad AlSabah gave some examples of expenses related to the Arab Spring in GCC countries, as follows:
Bahrain: To counter the dangerous sectarian divide, the government pledged to spend $6.6 billion on the housing sector.
UAE: New food subsidies were introduced, retirement pensions were raised by 70%, and $2 billion was pledged in the form of housing loans in the Northern Emirates, while the Abu Dhabi government allocated $600 million to provide housing loans to its citizens in the emirate.
Saudi Arabia: The government announced in 2011 a program worth $130 billion to combat youth unemployment and provide other social services.
Oman: The government pledged to allocate $1.3 billion for social benefits and to create 50,000 new job opportunities in the public sector.
Qatar: The government pledged to provide $8.1 billion worth of social services, including a significant increase in public sector salaries.
Kuwait: Public spending jumped from $40 billion in 2009/2010 to $57 billion in 2010/2011, and is expected to reach $69 billion for 2011/2012, an increase of 31.5% annually.
Source: Al-Qabas