Are Rentier Monarchies a Viable Road to Development in the Gulf States

Content

1 Introduction
1.1 How Could Oil Be a Curse?
1.2 Question and Thesis
1.3 Structure

2 The Oil Challenge
2.1 Theoretical Background
2.1.1 The Failure of “Big Push” Theories
2.1.2 The Rentier State Theorem
2.2 State-Sector
2.2.1 State-Dominance
2.2.2 Protectionism
2.2.3 Corruption
2.3 Private Sector
2.3.1 Unbalanced Investments
2.3.2 Rent-Seeking Behaviour
2.3.3 Deficits in Human Capital
2.4 State-Society Relationship
2.4.1 Lack of Accountability
2.4.2 Lack of Modernisation

3 Conclusion

4 Literature

1 Introduction

1.1 How Could Oil Be a Curse?

What must go wrong before economists label a scarce and strategically valuable commodity like oil a “curse”? Fundamental economics suggests that they are almost as good as cash. Abundant natural resources can help a country prosper through earnings of hard currencies, larger and diversified domestic investments in physical and human capital, and acquisition of foreign technology.^[1] Furthermore, despite attempts to diversify the energy portfolio, oil still is the world’s most important energy source.^[2]

Nevertheless, when BBC launched the TV series “The Curse of Oil” in September 2004, no incident of protesting economists became known. This might be due to another lesson from history, namely the “natural resources paradox”: Oil – or natural resources in general – might not exactly be “as good as cash”. Rather, they could have negative impacts on the development of an economy, i.e. a process towards a stable, sustainable and diversified economy. The most obvious example of the natural resources paradox are conflict-ridden countries like Nigeria. Analysts argue that natural resource abundance is one of the reasons for destructive political conflicts.^[3] But even politically stable countries, which enjoy a high GDP per capita due to the exploitation of natural resources, show a negative correlation between oil and development. An obvious example of this is the performance of the member countries of the Gulf Cooperation Council (GCC). On the one hand, all of these oil monarchies enjoy a high GDP per capita (cf.figure1).^[4]

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Figure1: World Bank Classification of GCC Countries

On the other hand, the development performance within the GCC differs considerably. Data shows a correlation between the performance of these economies over the last years and their outlook in regard to their oil reserves: The fewer the oil reserves are, the better tends to be the performance in terms of a sustainable, diversified development. Figure2 shows that three countries (Bahrain, Dubai as a part of the Emirates, and to a lesser extent Oman) face the threat of depletion of oil reserves within the next generation, whereas Saudi-Arabia, Kuwait, Abu Dhabi, and Qatar and have much larger reserves.

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Figure2: Expected Oil Reserves of GCC Countries^[7]

This “oil data” negatively correlates with “diversification data”. Figure3 shows that Bahrain and the Emirates are more diversified than the other economies. The latter countries seem to adapt slowly but nevertheless visibly to the “race against time” between accumulating sufficient productive human and physical capital in the non-oil sectors and the depletion of oil reserves.^[8]

Figure3: Dependency on Oil

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A closer analysis of the UAE and of the differences between the two dominant members, Abu Dhabi and Dubai, gives further evidence for the correlation thesis. Abu Dhabi holds about 94% of the UAE´s total oil and gas reserves; unsurprisingly its economy is highly concentrated on the hydrocarbon sector. In contrast, Dubai produces relatively little oil (170000 bpd, in contrast to 2million bpd in Abu Dhabi), and has a more diversified economy, which includes almost all manufacturing industries of the UAE. Hence, the non-oil sector accounts for 90% of Dubai’s GDP.^[9] Taking this data together, figure4 shows that the Emirates and and Bahrain perform better than the rest of the GCC.^[10]

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Figure4: Oil Exports and Oil Revenue/Total Government Revenue 1998-2002^[11]

In conclusion, high natural resource abundance correlates with “one commodity” economies and a rather bad development performance, even in countries with a high GDP.

1.2 Question and Thesis

The correlation between lack of development and high natural resource abundance just presented leads to a rather simple question: Why do economies with a large natural resource abundance perform worse in terms of sustainable development than countries with smaller natural resource abundance – or more technical: Is there a causal story that could be added to the correlation between the two observations? If there is a causal story between natural resource abundance and lack of development, oil might be considered an obstacle rather than an encouragement to development. The following chapters describes these causal mechanisms between natural resource abundance and low development. The argument follows a rather simple theorem, summed up by Steven Landsburg as follows:

Most of economics can be summarized in four words: “People respond to incentives”; all the rest is commentary.^[12]

Appliance of this fundamental assumption of economics to our question suggests that the reason for the failures of reforms are wrong incentives inside the GCC economic and political systems, which are closely connected to the main feature of GCC economies: scarcity rents, gained by exploitation of oil.^[13] Scarcity rents set highly problematic incentives that lead to huge inefficiencies inside the economy like a lack of diversification and misguided flows of investments, an economic sector dominated by a corrupt state, rent-seeking behaviour of the private sector, less investment in human capital, and problematic state-society relationship. Reforms fail because this system remains at equilibrium as long as rents are available. As long as this equilibrium between rent-distributing state and rent-seeking private sector exists, reforms towards more development face severe obstacles. The same argument explains the better performance of Bahrain or Dubai: If people react to incentives, a threatening non-availability of rents (i.e. depletion of oil reserves) should lead to stronger efforts to diversify the economy.

1.3 Structure

Chapter2 takes on the thesis of an “oil challenge” and describes mechanisms of how natural resource abundance does influence economies and societies in the Gulf region. Chapter2.1 gives a brief outline of the rentier state concept. The following chapter analyse the incentives set by oil rents regarding the state sector (chapter2.2), the private sector (chapter2.3), and the state-society relationship (chapter2.4). Finally, chapter3 summarises the results.

2 The Oil Challenge

2.1 Theoretical Background

2.1.1 The Failure of “Big Push” Theories

Chapter1 already mentioned that a conventional assumption is that natural resource abundance would influence the development of economic growth and wealth positively.^[14] Economic theories influenced by Rostow´s stage model predicted the launch of a “big push” towards industrialisation and diversification if contributions of industrialisation in one sector are used to enlarge the size of the market in other sectors.^[15] Big push theories emphasise the role of the state in this process, which helps to overcome an investment trap that hinders the coordination of investment efforts in underdeveloped sectors and move on from a “cottage production equilibrium to industrial equilibrium.”^[16] The state should “take on the role of stimulating and coordinating complementary investments, and thereby unambiguously improve welfare.”^[17]

The idea of a big push sounds – as many development theories that identify a single “missing component”^[18] – too good to be true. Indeed, there are both theoretical and empirical reasons against big push theories. First, big push theories assumes unrealistically a benevolent government. Public Choice theory shows that selfish behaviour, rent seeking and corruption should be taken into account.^[19] Second, there is a lack of empirical evidence. There is no robust empirical association between natural resource abundance and national savings, national investments or rates of human capital accumulation.^[20] Sachs/Warner found that economies with a high ratio of natural resource exports to GDP tend to grow slower.^[21]

2.1.2 The Rentier State Theorem

In contrast to the optimistic view of big push theories, the rentier state theorem predicts that states do not behave benevolent. The more natural resources are available, the more likely the state will be too big, corrupt and set wrong incentives for the market. At the core of the concept are “rents”, which could be defined as “the economic return that accrues or should accrue to land from its use in production”.^[22] Specifically, the rentier state concept refers to scarcity rents, or a return earned on a factor of production that is scarce and exhaustible. Because of its scarcity, the market price of the commodity exceeds the current cost of production. The difference between the competitive price of the commodity and the current cost of extraction in such a market is the scarcity rent, or an “income derived from the gift of nature”.^[23] Accordingly, a rentier state is defined as a state that is reliant not on the extraction of the population’s surplus production, but on the extraction of externally generated revenues, in our case oil.^[24]

Why are rentier economies problematic? What are the incentives set by scarcity rents that lead to a poor economic performance? The following chapter analyses the incentives set by natural resource abundance and scarcity rents in three distinct areas: (1) the state sector, (2) the private sector, and (3) state-society relations. In the state sector, natural resource abundance and scarcity rents set incentives for three sets of behaviour: (a) a big state-sector with allocative functions, (b) protectionist policy for other trading sectors than oil, and (c) corruption. In the private sector, (a) an unbalanced flow of investment in the oil sector thwarts any diversification attempts of the state, (b) rent seeking behaviour and (c) a lack of incentives for investment in human capital can be detected. Finally, state-society relations are characterised by a lack of accountability of the state and a lack of modernisation. Figure5 shows the incentives set by natural resource abundance for the state sector, the private sector, and state-society relations.

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Figure5 Causal Links Between Natural Resource Abundance and Development Deficits

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^[1] Cf.Amuzegar (1999): P.189f.

^[2] The European Commission estimates that in the year 2030, 34% of world’s energy consumption will rely on oil. Cf.European Commission (2004): P.1.

^[3] Cf.Collier/Hoeffler (1998).

^[4] Cf.CIA Factbook. http://www.cia.gov/cia/publications/factbook/rankorder/2004rank.html

^[5] The World Bank Income Classification is based on the 2003 GNI per capita. The groups are: low income, $765 or less; lower middle income, $766 - $3035; upper middle income, $3036 - $9385; and high income, $9386 or more. Cf.http://www.worldbank.org/data/countryclass/countryclass.html.

^[6] Low- and middle-income economies are classified as “less indebted” if the four key ratios debt to GNI (50%), debt to exports (275%), debt service to export (30%) and interest to exports (20%) remain under 60%. Cf.http://www.worldbank.org/data/countryclass/countryclass.html.

^[7] Cf.www.eia.doe.gov/emeu/iea/table81.html

^[8] Cf.Kubursi (1984): P.1.

^[9] Cf.Oxford Business Group (2005): www.oxfordbusinessgroup.com/country.asp?country=16#eco

^[10] Cf.Rivlin (2001): P.57.

^[11] Cf.Fasano/Iqbal (2003).

^[12] Landsburg (1995): P.3. Cf.Easterly (1999).

^[13] Cf.Chapter 2.1.2.

^[14] Cf.Auty (1995): P.184; Leite/Weidmann (1999): P.3; Sachs/Warner (1995): P.3.

^[15] Cf.Sachs/Warner (1999): P.44; Murphy/Shleifer/Vishny (1989): P.1004. In theoretical terms, this theory assumes that optimality would be attained when the marginal rate of return of the usage of oil-based resources in non-oil sectors is equalised. Cf.Amuzegar (1999): P.11.

^[16] Murphy/Shleifer/Vishny (1989): P.1004.

^[17] Cf.Fontenay (1999): P.2.

^[18] Cf.Townsend (1984): “The missing component is a factor (for example, capital, or foreign exchange, or education and skills) which, if only it could be added to the overall resource base of a given undeveloped or underdeveloped country would permit that country to move towards developed status. A refinement of the missing component theme has been described as the critical minimum effort theory, otherwise “the big push”. This approach maintains that the vicious circle of poverty can only be broken when the missing component is provided by a massive injection of foreign capital or foreign skills.” P.37.

^[19] Cf.Jalali-Naini (2003): “It is fairly well established that if the government becomes big relative to the market, interest groups inside and outside the government grow in number and the potential for rent seeking increases, what happens to the endogenous-growth effect of public goods in this case.” P.5. Cf.Fontenay (1999): P.2 f.

^[20] Cf.Auty (1995): “Despite these potential advantages, the mineral economies have seldom outperformed other groups of developing countries, and the achievements of individual mineral economies have been eratic.” P.185.

^[21] Cf.Sachs-Warner (1999). Cf.Sarraf/Jiwanj (2003): P.3.

^[22] Cf.Barlowe (1978): P.162.

^[23] Cf.Marshall (1920): P.350. In a strict sense, pure rents are very rare, if not impossible. Nearly all income contains elements, which are derived from effort invested. Cf.Marshall (1920): P.350. In this sense, scarcity rents are more a gradual than an absolute category.

^[24] Cf.Beblawi (1987): P.51. In addition, Beblawi/Luciani define a political system as a rentier state only if a minority in the population is engaged in the generation of the rent, while the majority is involved only in the distribution or utilisation of it. Cf.Beblawi/Luciani (1987): P.11. Luciani (1987) proposes the differentiation between “production” and “allocation states”. Cf.p.69. In practice, the definition of a country as a rentier states is a matter of judgement. To facilitate this judgement, most studies rely on the rather static term of a “mineral economy” of the World Bank. From this perspective, a mineral economy is one where mineral production constitutes at least 10% or GDP and where mineral exports comprise at least 40% of total exports. In the case of the GCC economies, both criteria are met. Cf.DiJohn (2002): P.2; Auty (1995): P.182.