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The economics of Saudi Arabia

By Rachel Shey
web posted November 11, 2019

Back when I took AP World History, the Middle East in the Postclassical era was my favorite part.  Who could resist the fabulous tales of Ibn Battuta, the fabled escapades of Muhammad in the early days of Islam, the story of a sudden and meteoric rise to power which left Arab imprints from China to Spain (crossing the continent!)?  Who could find the story of the Umayyad Caliphate, which spread Dar al-Islam to the Iberian Peninsula, boring?  If even those are not enough to grip your attention, take note of this cinematic quote from Suleiman the Magnificent, who presided over the Ottoman Empire at its peak: “I, the sultan of sultans, and the strongest ruler, the loftiest king who defeats the kingdoms around the world, and the shadow of Allah in the Earth, am the son of Sultan Selim who is the son of Sultan Beyazid, Sultan Suleiman, Caesar of Rome, the sultan of Mediterranean Sea and Black Sea, and Thrace, and Anatolia, and Karaman and the City of Dulkadir and Diyarbakir and Kurdistan, and Iran and Damascus and Aleppo and Egypt and Mecca and Medinah and Jerusalem and the whole Arab land and Yemen and many more lands that our lofty ancestors conquered with their crushing powers and I conquered with my fire-scattering sword….”  Most fantastic of all is the Hagia Sophia, originally a Greek Orthodox Church which was refashioned into an Ottoman imperial mosque and is now a museum in Istanbul.  And yet, although Saudi Arabia was historically the cradle of civilization, the birthplace of these wondrous stories, it has not aged well.  How shall we bring the largest country of the Middle East to modern economic standards, take it to its highest possible productivity, and liberate it from the resource curse? 

Saudi Arabia, by most economic metrics, has not been doing well lately.  Its GDP growth rate is -1.3%, its inflation rate is -0.7%, and most figures show that it’s dropping overall.  Stepping away from granular statistics, Saudi Arabia isn’t in the best of economic situations, as a big picture.  Its economic model is described by Karen Elliott House (in her book On Saudi Arabia: Its People, past, Religion, Fault Lines and Future) as:

“a bewildering (at least to outsiders) combination of a feudal fealty system and a more modern political patronage one. At every level in every sphere of activity, Saudis maneuver through life manipulating individual privileges, favors, obligations, and connections. By the same token, the government bureaucracy is a maze of overlapping or conflicting power center under the patronage of various royal princes with their own priorities and agendas to pursue and dependents to satisfy.” 

While Saudi Arabia was, for a time, a subsistence economy, after it began to take advantage of its oil resources, the monarchy realized that it had to loosen its binds on the economy to diversify and improve.  Today it’s considered a free market, but it has a massive welfare state and subsidizes nearly all of its citizens (all state employees), handing out 1000 riyals each month - a policy that costs 50 billion riyals, or 13 billion USD. 

In addition, there’s also the newly introduced policy of Saudization, formally known as the Saudi Nationalization Scheme, which requires jobs to be filled with certain quotas of Saudi nationals.  The idea was to lower unemployment rates, as a large number (12.9% in 2018, currently 5.6%) of Saudis are unemployed, or employed minimally, because of the welfare state, coupled with the fact that most jobs in the private sector are occupied by foreign workers. 

Although clearly not operating close to its production possibilities frontier, Saudi Arabia can afford a degree of inefficiency in its economy because of its massive stores of cheap oil.  Saudi oil is plentiful, close to the surface, and under pressure, making it extremely easy to extract.  Oil accounts for 42% of GDP, 90% of exports, and 87% of Saudi revenues, and this is what allows the government to support so many citizens’ incomes.  Saudi Arabia’s economy is unwisely reliant on oil (the resource curse) and on foreign labor. 

On the trade frontier, however, Saudi Arabia is doing quite well (at least according to mercantilist principles, as elaborated in Dr. Richman’s essay Free Trade vs Balanced Trade).  It has a large trade surplus, which can mean several things.  First of all, if it isn’t importing as many goods, that means it’s producing them in-country, which could indicate inefficiency, as the Saudis are failing to fully optimize to their comparative advantage.  Second of all, a surplus usually helps a country’s economy grow quickly, by increasing the benefits of technological advances, so it could also mean that Saudis are “beggaring off their neighbors” and coming out on top for it. 

How can the issues of inefficiency and unemployment be remedied?  Well, some catch-up growth is necessary.  Job creation is a must, and piggybacking on technology from other more advanced countries could also help.  Saudi Arabia’s strong trade front can help with this, but not if it continues to be almost completely reliant on oil money.  Fostering entrepreneurship by having the government take a more ‘hands off’ approach and allowing firms to employ whoever they want, can help turn the Saudi economy into a more active and vibrant free market.  Borrowing from Paul Romer’s ideas as discussed in my last essay, Saudi Arabia could try setting up charter cities to foster a free market - one of its problems is a lack of infrastructure.  In fact, it’s currently building five “economic cities,” like King Abdullah Economic City, with a port, an Industrial Valley (for manufacturing/factory-building), a resort, residential areas, an education zone, and a business district. Other potential cities include “Ethraa, The Smart City,” “Health Care City,” and “KAEC Media City.” 

Saudi Arabia does have a plan to improve its economy as well.  It’s called Saudi Vision 2030, and it includes mostly “boondoggles” a la the New Deal - projects for luxury resorts, the construction of more entertainment centers, issuance of tourism visas, and a number of other renovation projects in large existing cities like Jeddah.  However, I think Saudi Arabia should also work on fixing the structural inefficiencies of its economy.  These projects are only bandages that will briefly stimulate growth, but the country must also move toward a freer market overall, a smaller welfare state, and more inbuilt incentives to allow Adam Smith’s invisible hand to take effect.  ESR

© 2019 Rachel Shey

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