Summary: Signs of a slowdown in Vision 2030; fiscal austerity has solved short term economic problems but long term future growth prospects remain challenging.
Saudi Arabia receives 90% of its revenue from oil so when the oil price dropped sharply in 2014 its economy was badly affected, prompting the IMF to warn that the Kingdom could be bankrupt by 2020 if it did not undertake major economic reforms.
Since then a far reaching reform plan has been introduced, Vision 2030, which if successful will be the first time a major economy reliant on petrodollars has been converted into one suitable for the post-oil 21st century. Two years after this process began however signs of a slowdown are emerging as the government seeks to balance the need to save more money with the impact the measures are having on society and the risk of a clash with the conservative religious establishment.
Last week Finance Minister Mohammed Al-Jadaan told Bloomberg that cuts to energy subsidies may be more gradual and the government might take longer to balance its budget. The sale of a stake in Aramco, which underpins the plan, is also now facing possible delay. Reports that the IPO is on the brink of collapse have been dismissed by Aramco as “entirely speculative”. “All listing venues under review for optimal decision, IPO process is on track for 2018” the company tweeted on Saturday.
We thank Nick Stadtmiller for the article below which considers the economics behind Vision 2030. The article does not attempt to address the economic impact of money skimmed off by the royal family which we commented on in our posting of 31 May.
Nick is a US-based analyst focusing on economic trends impacting the GCC. He worked in the region for eight years, including two years as an advisor with a branch of the Dubai government and a six-year stint with one of the UAE’s largest banks. The views expressed in the article are the author’s own.
Crunching the numbers behind Vision 2030
The 2014 dive in oil prices generated shockwaves across the Saudi economy. After years of fiscal surpluses, the Saudi government ran deficits exceeding 15% of GDP in both 2015 and 2016. SAMA, the Saudi central bank, had over US$ 740bn in FX reserves in mid-2014, following years of large trade surpluses generated by oil exports. By the end of 2015, those reserves had shrunk by nearly 20%. SAMA’s FX reserves are now less than two-thirds of their 2014 high.
Saudi authorities cut spending in response to the decline in oil receipts. Budgeted expenditure in 2017 is 20% lower than 2014 outlays. Fiscal austerity is a necessary short-term response to the decline in oil revenues, but it is insufficient as a long-term response. The Kingdom also faces the challenge of creating economic opportunities for a young population; nearly half of Saudi citizens are under the age of 25. The already bloated public sector cannot afford to absorb large numbers of new Saudi entrants to the labour force, especially in a period of austerity. Authorities must find ways to create new economic opportunities for nationals, especially the young.
It was in this context that Vision 2030 was created, led by the Kingdom’s ambitious Crown Prince Mohammed bin Salman. Vision 2030 envisages changes across Saudi society. From an economic standpoint, perhaps the most important plank of this programme is to raise the private sector’s contribution to GDP to 65%, from its current share of 40%. Growing the private sector is necessary when the future economic contribution of oil is uncertain, and the government can no longer afford to be the engine of growth.
In order for the private sector to raise its share of output to 65%, it will need to grow by 7.9% annually, assuming that output from the oil and government sectors remains constant in real terms. That would generate non-oil GDP growth of 6.3% per annum.
Some of this growth will come from increases in the labour force. Saudi Arabia’s population is forecast to grow at 1.9% annually in the coming years, based on UN Population Division projections. In addition, authorities expect to increase women’s participation in the labour force. Vision 2030 sets a goal of raising women’s participation rate from 22% now to 30% by the end of the next decade. This would boost labour force growth to 2.3% per annum.
With labour force growth of this level, output per worker — or productivity — would need to rise by nearly 4% per annum in order to achieve the economic growth necessary to reach goals set out in Vision 2030. Growth in output per worker of 4% is comparable to levels seen in many developing countries in recent years. The Asian Tigers were able to exceed this level during their growth spurts in the last century.
However, Saudi Arabia is setting off on a development programme with a much higher average income than in most developing countries. Per-capita GDP in Saudi Arabia was just over US$21,000 last year (in constant 2011 dollars), based on World Bank data. That is over two-and-a-half times per-person incomes in upper-middle income nations.
Most countries that experienced rapid growth were able to use cheap labour to build a competitive manufacturing sector as part of their development strategy. Saudi Arabia’s per-capita income is too high to pursue this path. Authorities will have to focus on building opportunities in higher value-added industries to spur growth and offer higher-income job opportunities.
The Saudi government will have to make significant improvements to the existing stock of human capital to propel growth in higher value-added industries. Saudi companies have historically utilised low-cost, low-skill labour from abroad — mainly South Asia — to drive growth. Over two million foreign workers out of a total of 11 million are employed in domestic labour. Over 40% of expatriate labourers working in non-domestic roles are employed in the construction sector, primarily in unskilled manual labour. Saudi authorities need to attract higher-skilled expatriates in the coming years in order to grow higher value-added industries.
The government must also ensure that Saudi nationals have the necessary skills to gain meaningful employment in emerging industries. Educational outcomes in the Kingdom are disappointing. Even though Saudi Arabia’s spending on education is close to the OECD average, Saudi students lag behind their international peers. The TIMSS survey puts Saudi students near the bottom of their league table of achievement in science and mathematics. Authorities will have to focus on vocational training and other schemes to up-skill its national workforce.
Economic theory states that productivity can be raised by increasing the amount of capital per worker. My calculations indicate that in order to create 4% productivity growth, authorities would need to make annual investments in capital of 25% of GDP in the near term. There are several caveats to this assertion. The first is that the capital stock must grow faster than economic output in order to sustain productivity growth. This means the ratio of investment to GDP would have to rise in order to maintain constant productivity growth. By 2030, annual investment would need to reach 40% of GDP.
Furthermore, in order to earn an adequate return on capital investments, they must be economically productive. The most advanced technology is worthless if there are no workers suitably trained to use it. Progress in developing human capital will thus serve as a constraint on investment in new industries.
It is difficult to imagine that Saudi Arabia will be able to generate sustained productivity growth of 4% given current economic realities. Future growth will have to come from higher value-added industries, and the labour force currently appears ill-prepared for this transition. Economic reality always trumps ambition, no matter how bold. Current conditions are a limiting factor for what the Kingdom can achieve economically.
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