Gulf economies

How to spend it

A region awash with oil money has one or two clouds on the horizon

THE Gulf is full of loud architectural statements—towers that reach over 600 metres into the sky, hotels that will be suspended under the sea. It is easy, then, to miss the quiet resonance of Imperial College London's gleaming diabetes centre in Abu Dhabi, the capital of the United Arab Emirates (UAE). The building is decorated with tessellated plates of aluminium, a pattern inspired by the geometry of an insulin crystal and the musharabiya latticework of the region's past.

Opened in 2006, the hospital now cares for 6,000 patients, who pass through its chain of tests and treatments in a single visit. Almost a fifth of the UAE's native population suffers from diabetes, a rate second only to Nauru's. Next come three fellow members of the Gulf Co-operation Council (GCC)—Saudi Arabia (16.7%), Bahrain (15.2%) and Kuwait (14.4%).

The ailment is one unhappy consequence of the region's economic transformation. Before 1961, Abu Dhabi lacked even a paved road. Since then, it has enjoyed a startling transition from pearling to petroleum, from souk to mall and from sand to glass. This prosperity has bought a sedentary lifestyle and a sugary diet, which may have triggered a genetic predisposition to diabetes among Arabs. In the neighbouring emirate of Dubai shoppers are invited to enrol in “Mall Walkers”, a power-walking club that promises to give more than your credit card a workout.

Diabetes is a useful metaphor for the Gulf's present problems. The region's economies are struggling to absorb petrodollars, accumulating like glucose in the bloodstream. The risk they face is the economic equivalent of renal failure: inflation, a hollowing-out of the non-oil sector, and a young, growing workforce in chronic need of outside labour to supplement it.

The six nations of the GCC, which also includes Qatar and Oman, earned $381 billion from their exports of oil in 2007 and another $26 billion from gas, according to the Institute of International Finance (IIF). If the oil price remains at about $100 a barrel, they will reap a cumulative windfall of almost $9 trillion by 2020, reckons the McKinsey Global Institute: a vast number relative to the size of the GCC economies, which had a combined GDP of $800 billion in 2007.

Not all these riches are ingested, of course. The Gulf added $215 billion to its stock of foreign assets in 2007, the IIF calculates. This hoard is divided between the region's central banks, its sovereign-wealth funds and its wealthy sovereigns. It added up to $1.8 trillion by the end of last year, by the IIF's estimates, and more like $2.4 trillion, according to Brad Setser of the Council on Foreign Relations and Rachel Ziemba of RGE Monitor.

This financial clout has aroused anxiety, especially as some of the smaller funds have ventured beyond bank deposits, government bonds and minority stakes into less anonymous investments. In March the government of Abu Dhabi wrote letters to finance ministers around the world, explaining the motives guiding its investments. Its funds are only in it for the money, the letters said.

It is a plausible claim. If the Gulf is now a financial superpower, as Mr Setser and Ms Ziemba put it, then it has had its greatness thrust upon it. Its dollar surpluses were accumulated more by accident than design. The region's governments, scarred by the cheap oil of the 1990s, were slow to believe high prices would last. Their revenues then outpaced their ability to spend.

Slowly, however, the Gulf states' domestic ambitions have begun to catch up with their greater means. The six members of the GCC have announced or begun projects worth $1.9 trillion, according to Middle Eastern Economic Digest, 43% more than a year ago. The magnitude and mystique of the Gulf's foreign investments may arouse curiosity and concern. But what is more remarkable is how much the Gulf is now trying to spend on itself.

An avenue in the desert

No one could accuse Dubai of hoarding rather than flaunting wealth. For those not content with five-star luxury it offers the sail-shaped Burj al-Arab, the world's only seven-star hotel. Guests arrive by helicopter or Rolls-Royce, watch 42-inch plasma TV-screens in their rooms and choose from 13 pillows on which to lay their heads.

Dubai makes an exhibition of its prosperity because its economy now depends on people with money. With only a tiny percentage of the UAE's oil reserves, it has become adept at conjuring up ventures for others to finance. Now that its more conservative neighbours, such as Saudi Arabia and Abu Dhabi, are keen to invest more at home, they are learning from Dubai the arts of immodesty and audacity.

There are few better tutors than Emaar, one of Dubai's big-three developers, best known for building the Burj Dubai, the world's tallest tower. In 2006 its Saudi offshoot raised 2.55 billion riyals ($680m) to build a metropolis on the Red Sea coast, 100km north of Jeddah. The King Abdullah Economic City (KAEC), due for completion in 2016, will have over 2,000 factories and 2m people. Its resorts will offer 22,500 rooms and its port will dwarf the Islamic Seaport in Jeddah, handling the equivalent of 20m 20-foot containers a year and 300,000 pilgrims bound for Mecca.

In the last oil boom, new industrial cities such as Yanbu and Jubail arose at the government's behest. But Emaar raised its money from local investors in an oversubscribed public offering. Such “stockmarket hullabaloo” was new to Saudi Arabia, one critic says. Indeed, the private sector has never before taken on a city of this size.

Over the entrance to the site hangs a portrait of King Abdullah, looking down benignly. The archway marks the beginning of a 17km road lined with palm trees, which cannot disguise the dusty emptiness that extends for miles on either side. The wind-blown sand forms natural speed bumps along the route. Where the road meets the sea, construction has begun. A rig pounds an inlet out of the coast, sending rubble rattling down a pipe to the sea. Workers take a moment to pray, bending like the palm trees in the wind.

Emaar makes its money selling dream properties “off-plan” (ie, before they are built), using the proceeds to turn the rendering into a reality. In Dubai the model works well, thanks to the strength of Emaar's brand and the speed of Dubai's administration. In Saudi Arabia, buyers are more wary and the ministries less brisk. Emaar has recently agreed to lease industrial space to a Saudi-French lubricants company and an aluminium joint-venture from Abu Dhabi and Dubai. But the Saudi king, visiting last August, seemed unimpressed with progress. The deadline was tightened from 2026 to 2016. In February an even bigger “industrial zone” was announced, Sudair City, which will be financed mostly by the government.

Emaar faces another speed bump common to the entire region: the mounting cost of men and materials. Cement, steel, even sand are becoming pricier, and engineers are in short supply. Inflation, which reached 8.7% in February, is a shock to the Saudis, whose central bankers are as conservative as their clerics. In Oman the rate is 11.1%, an 18-year record. In the UAE and Qatar it is also well into double digits.

Behind these disturbing numbers lie three economic forces. First is the rise in the world price of commodities, especially food, thanks to strong demand and strained supply. Second is the fall of the dollar, to which all Gulf currencies are pegged except the Kuwaiti dinar. The third force is less familiar. It is the rise in the price of non-traded goods, principally housing and office space, which is arguably a natural result of the oil boom, and may even help the Gulf absorb its new riches.

The high price of food can tax even the hardiest consumer. The cost of good camel fodder has more than doubled in eight months, says Sameh Musabha, who watches four of his 80-strong herd trot around the race track in the UAE's tiny emirate, Ras al-Khaimah. “Everything is expensive now,” he says. At the Two-Dirham Plaza nearby, many items now sell for five.

The fall of the greenback, meanwhile, has raised the price of those imports not invoiced in dollars. Foreign workers complain bitterly that the money they earn in the Gulf stretches less far when sent to their families in India, Pakistan or Britain. The peg has forced the Gulf's central banks to shadow America's Federal Reserve, even as their economies have parted ways.

Might they re-peg their currencies at a stronger rate, or abandon the peg altogether? A meeting of the GCC in December dismissed the idea, saying that a rejigging of rates might jeopardise their ambition of monetary union in 2010. A stronger reason, suggests John Sfakianakis, chief economist of Saudi British Bank (SABB) in Riyadh, was Saudi Arabia's reluctance to undermine the dollar, the currency of its closest ally. But Qatar's prime minister thinks his currency is 30% undervalued, and he may still break ranks.

Disappearing dhows

Even if the dollar were steady, the region's prices would be unstable. This is because if the Gulf is to absorb its petrodollars, the price mechanism has work to do.

When an energy exporter converts its petrodollars at the central bank, domestic spending rises. But unless the local economy has a lot of slack, it cannot magically produce more goods and services to meet this fresh demand. Their price instead rises, relative to the price of things that can come in from overseas. According to a study by three IMF economists, a doubling of the oil price results eventually in a 50% rise in the price of non-tradable goods (such as housing), relative to tradables.

This shows up as inflation. But the price rises should peter out once they have served two useful functions: diverting demand to goods from abroad, and increasing the supply of those goods and services that must be produced at home.

You can see this macroeconomics at work all over the UAE. By Dubai's old creek, wide-bottomed dhows, moored four abreast, are hidden by the cargo piled on the wharf. Car parts from Germany, seedless tamarind from Myanmar and basmati rice from Pakistan are offloaded by small cranes from China. Meanwhile the price of housing, a service that must be consumed where it is produced, is soaring. In Dubai, rents rose by 30% in 2006 and another 17% in 2007. The government has tried to cap increases at 5% this year, but landlords turf tenants out on any pretext and charge 30-40% more when they re-let. Office space in Dubai now costs almost as much as in midtown Manhattan.

A camel-boy from Bangladesh

Some goods and services cannot be imported, but the labour required to produce them can be. In the Gulf, immigration serves almost as a tool of macroeconomic stabilisation, keeping wages contained. Illiterate young men from rural Pakistan fly into Riyadh, Saudi Arabia's capital, their passports signed with a thumbprint. At the luggage carousel, they pick up bundles of oranges they will sell before taking up jobs driving trucks or twisting steel across the kingdom. In Dubai, workers from South Asia are shuttled in from desert labour camps in the same yellow buses that ferry American children to school. They file on to construction sites, an arm draped over the man in front.

The Gulf has long assumed this queue of workers was endless. But some construction companies now struggle to find ready manpower. Labourers have dared to demand better wages. On March 18th hundreds of workers in the emirate of Sharjah torched cars and buildings in a labour camp in a protest over pay. In February 45 Indian builders were condemned to jail and deportation for violent protests.

The migrants have some backing in their home countries. In Bahrain, the Indian government has requested that their nationals be paid a minimum wage, much to the resentment of the Bahraini government. But Bahrain is itself pioneering a sweeping reform of its labour market, designed to make foreign labour more expensive. From July 1st it will charge companies a monthly levy of 10 dinars ($26) for each foreign employee on their books, in addition to a visa fee of 200 dinars.

This ambivalence towards foreign labour is shared across the Gulf. The native-born want to enjoy the profits and products that immigrant labour makes possible. But they do not want to face the competition immigrants bring. Foreigners do 60% of private-sector jobs in the GCC region; in the UAE, they do over 90%. Even Mr Musabha, the camel-owner, employs a young apprentice from Bangladesh.

Many nationals find work instead on swollen government payrolls, underwritten by petrodollars. But Bahrain's oil-fields are running dry and Saudi Arabia's deep reserves are spread thinly over a large population (25m) that is growing faster than oil output. The country is no stranger to poverty. In old Jeddah, beautiful coral houses sink into dilapidation. Elderly women watched by stray cats search for the best picks from the city's rubbish skips.

The Saudi and Bahraini states cannot afford to employ every citizen who wants a job. But the “petrodollar wage” still casts a long shadow, setting expectations and raising living costs. Elsewhere in the world the private sector would compete with the government for labour, offering comparable pay. But in the Gulf private employers hire immigrants instead. This leaves many Saudis and Bahrainis in limbo. They cannot count on a government job; nor will they settle for a low private-sector wage.

Licensed layabouts

According to McKinsey, the Gulf economies need to create 280,000 jobs a year to employ the young citizens graduating from schools and universities. But despite some of the lowest student-teacher ratios in the world, many emerge with few marketable skills. One response is to force companies to hire locals, imposing quotas in the name of Omanisation or Saudi-isation. But this measure undermines the work ethic of locals and the morale of immigrants. McKinsey reckons a quarter of native employees in Bahrain, Saudi Arabia and the UAE fail to show up for work.

Another response is to foster new industries other than oil, which employs too few, and construction, which pays too little. Saudi Arabia has made progress privatising telecoms, liberalising airlines and opening up financial services. It is also pinning great hopes on its economic cities, of which KAEC is but one of six. The others include a Knowledge City near the holy city of Medina; a city based on steel, copper, aluminium and other heavy industries in Jizan; and a fourth that will nurture agri-business in Hail, which produces 90% of the country's corn and a third of its potatoes. All told, the cities are supposed to create 1.3m jobs by 2020.

Unfortunately, the region's diversification plans lack much diversity. For example, no fewer than 11 aluminium smelters are in the works, on top of two already in operation in Dubai and Bahrain. Mr Sfakianakis suspects the Gulf's governments have heard the same advice from the same cadres of consultants. The GCC is guilty of a “me-too” approach to industrial development, says a report by the National Bank of Kuwait, which raises the risk of over-capacity not just in aluminium, but also in petrochemicals and property.

In the small Gulf countries, such as Kuwait and Qatar, the economic task is rather different. Their governments' hydrocarbon revenues last year amounted to about $60,000 and over $90,000 per citizen respectively. These resources will not last for ever, of course. But that does not mean they need to diversify their production. By investing the proceeds of their energy sales in a broad range of assets, they can diversify their income instead. Over the long run, a diversified portfolio of stocks, bonds and property is likely to outperform oil anyway.

Their economic fate is the one imagined by John Maynard Keynes in his 1930 work, “Economic Possibilities for our Grandchildren”. In an age of easy prosperity, the struggle to ensure the citizenry is employed gives way to the challenge of keeping them occupied. How to avoid becoming a nation of coupon-clippers?

Abu Dhabi is experimenting with a more interesting future. In February ground was broken on the Masdar Institute of Science and Technology, the first step in an initiative to foster renewable-energy technologies, from conception to manufacture. The initiative will be based in a small eco-city, which will invite its citizens to economise on energy and escape from their cars.

The ground-breaking ceremony was powered by 24 solar panels of various designs, each competing for the bid to serve the city. In the site office the electricity meter turns backwards, an early example of Masdar's ambition to contribute electricity to the national grid beyond the power it needs to run itself. In a country dedicated to driving and drilling, Masdar is bold, perhaps quixotic. It is an attempt not so much to diversify the economy as to invert it. Is it a folly? The beauty of Abu Dhabi is that it has the money to make it work, and the money not to worry too much if it fails.