Saudi Arabia: Out of Options?
robert looney teaches economics at the Naval Postgraduate School in Monterey, Calif. This article is a follow-up to Looney’s essay on the Saudi economy that appeared in the First Quarter 2012 issue of the Milken Institute Review.
Published September 15, 2016.
The opinions expressed are solely those of the authors and do not necessarily represent the views of the Institute.
Saudi Arabia has largely been spared the domestic violence and political instability that has dogged much of the Middle East in recent decades, thanks mostly to its vast oil wealth — and, equally important, its dominance of the global oil market.
When oil gluts appeared, the royal family was able to buffer the impact on prices by reducing exports at its discretion. By the same token, when faced with rising domestic unemployment during the 2008-09 global financial crisis, the government could smooth troubled waters by expanding spending (by 26 percent) and ordering ministries to hire more Saudis. And, when the Arab Spring sent shockwaves through neighboring regimes in 2011, the government could again spend its way out of the crisis, mandating wage increases, giving bonuses to public employees and initiating a multi-billion-dollar housing construction program.
But since then, Saudi Arabia’s options for making problems go away have dwindled on the global front. When the technologically driven U.S. shale oil boom added millions of barrels to daily production, Saudi Arabia lost its leverage over the world oil price; cutbacks in production thereafter would only enable the shale producers to increase their market share.
As a consequence, Saudi Arabia’s GDP contracted by 13 percent in the wake of the 2014 price collapse. Wealth accumulated in the fat times did, however, allow the government to work its domestic magic once again: in 2015, it spent down $115 billion in financial reserves to maintain the living standards of ordinary Saudis rather than risk political unrest.
But this only highlighted the reality that, in this era of cheap oil, the royal family’s ability to satisfy all constituents is diminishing along with its cash reserves. After six decades of total dependence on oil revenues, Saudi Arabia is hardly in the position to make a gradual transition to a diversified economy that doesn’t thrive or dive depending on the price of petroleum. Youth unemployment, a critical stress point in many Arab Spring countries, continues to hover around 20 percent. And those Saudis who are employed are notorious for treating real work as an optional activity.
So, with the oil-heals-all-wounds model of governance no longer sustainable, Saudi authorities — or, more accurately, 30-year-old Saudi prince Muhammad bin Salman, the favorite son of King Salman — turned to McKinsey & Company for help in drawing up a new economic model. The resulting Vision 2030 plan boldly promises to phase out the country’s reliance on oil and generate $100 billion in non-oil revenue by 2020 while creating six million jobs in non-oil sectors by 2030. (The total Saudi-national workforce numbered 12 million in 2014.)
To demonstrate the government’s new commitment to a business-friendly fresh start, the plan included the sale of 5 percent of the state oil monopoly, Saudi Aramco, to private investors as well as limited privatization of other government assets. Meanwhile, a sweeping series of measures would shift the majority of workers from the public to the private sector.
In the same vein, foreign direct investment in Saudi industries would be encouraged. Government subsidies that keep every building over-chilled, every gas guzzler in high-octane fuel and every patch of lawn well irrigated would be phased out. Perhaps most striking, in a bid for tourist dollars and service jobs this most insular of countries would open its doors to foreign visitors, who are now mostly limited to religious pilgrims.
But, as is often the case with vision plans, the lofty goals invite skepticism. Start with the reality that oil revenues currently support around 90 percent of government expenditures. It simply would not be feasible for Saudi Arabia to break this dependency by 2020.
Vision 2030 also blurs reality on key resource constraints and political pitfalls. For example, even assuming that public sector employees can somehow be persuaded to move to private firms that pay lower wages, provide less job security and demand they show up on time, it’s far from clear that private employers, who have long complained that Saudi workers lack needed skills, would cooperate. Indeed, despite billions of dollars spent to improve education, and potent financial incentives already in place to hire locals, the existing private sector still relies heavily on foreign labor.
Then, too, there is the broader question of whether the average Saudi would passively accept a revision of the long-standing social contract whereby the state effectively guarantees a middle-class lifestyle in return for its citizens refraining from political activism or religious dissent.
Stepping back, it’s plain that Vision 2030 also glosses over important institutional deficiencies. Saudi Arabia is plagued by weak governance, not to mention debilitating levels of corruption. Transparency International ranks the kingdom 48th in the world on its Corruption Perceptions Index — admittedly an improvement over the past, but still worse than virtue-challenged Jordan and Namibia. Rapid economic change may not be impossible — think of the breakneck industrialization in South Korea and China — but it is safe to say that a transition as jet-propelled as Vision 2030 has never succeeded in a country as institutionally ill-prepared as Saudi Arabia.
Stepping back even further, one might ask why it took this long for Saudi Arabia to contemplate serious economic reform. One explanation is that most governments take the path of least resistance most of the time. But Saudi Arabia faces an even more formidable barrier in the Faustian bargain the royal family made long ago with fundamentalist Wahhabi clerics in which a religion that despises change became the guarantor of the government’s political legitimacy. How, after all, does one rapidly modernize the economy of a country with a state religion that defines the good old days as the 8th century?
At this point, there seems to be no way forward. Or back: In the unlikely event that oil prices return to pre-2014 levels, maintenance of the welfare-state-as-usual would mean increasingly severe budgetary shortfalls. Simply delivering on current entitlements for a growing population would require an oil price of $175 per barrel in 2025 and $320 in 2030. Which is none too likely; at those prices, frackers would start hunting for hydrocarbons under the Washington Mall.
So, what will happen? To quote President Nixon’s economist Herbert Stein out of context, “if something cannot go on forever, it will stop.” In the most plausible scenario, the royal family will inch away from radical changes when it hits serious resistance and then hope that marginal efforts to increase productivity and pare subsidies will distance the day of reckoning. Less likely, the royal family will bet its political legitimacy (and personal security) on the big bang implied by Vision 2030.
It’s no wonder, then, that almost everyone with a stake in Saudi Arabia's future is inclined to pretend that Vision 2030 will some day, some way yield the promised rainbows and unicorns. The only certainty is that rainbows and unicorns will have a tough time surviving in the Saudi desert.