How to diversify the economy: skills, skills, skills

Despite sustained efforts to diversify, GCC economies’ dependence on the oil and gas sector remains undiminished. Oil’s share in the economies’ total output may fluctuate in tandem with the oil price, but the underlying dependence has hardly budged.

According to the most recent estimates by the International Monetary Fund, the oil price required to balance the 2018 public accounts has risen in all GCC nations compared to the 2000-2014 average, on average by 31 per cent. The external accounts show a similarly unbroken dependence: for the GCC average, the oil price required to avert a current account deficit grew in the same period to $61 from $47, with only the UAE and Saudi Arabia seeing an improvement. Arguably, Dubai is the regional economy that has been most successful in creating a diversified non-oil economy, with other UAE emirates also showing promising developments. But overall, the regional hydrocarbon dependence looks much unchanged.

One cannot help be reminded of the famous optical illusions of Dutch graphic artist M.C. Escher: no matter where you are going, you always seem to be ending up in the same spot. In a GCC context: despite apparent progress in promoting the non-oil economy, why does hydrocarbon reliance not decline? Why does diversification remain so elusive? And what could be done to make true and lasting progress on making the economies more resilient to the vagaries of the oil market?

The strategies developed by the national authorities often focus on developing world-class infrastructure to underpin a transformation towards a more robust productive capacity in the non-resource sector.

Investment, often public-sector driven, has been buoyant across the region and its share in national output is above the typical level seen for emerging markets globally. That is good. Yet again, it only partly addresses the structural challenges of the region’s economies. To make the infrastructure boom bear plentiful and sustainable fruit two complementing efforts could render the investment strategy more powerful: improvements to the business environment and, most importantly, boosting the skills of citizens.

Judging from the World Bank’s Ease of Doing Business ranking, GCC sovereigns had performed relatively poorly in 2012. But instead of catching up with global peers, the regional economies fell further behind by 2017. Whatever business-friendly reforms were undertaken during the first half of the decade, the jurisdictions outside the region actually progressed faster and further.

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The only positive exception to this unwelcome trend is the UAE, which alone was able to improve its relative ranking, despite already having displayed a strong business environment to begin with. To become more attractive destinations for private sector investments, other GCC countries could do worse than to study the progress made in the UAE. The UAE demonstrates that the ease with which private sector business can be conducted is a result of purposeful policy choices, not of geography.

Upgrading skills is the second crucial ingredient to any lasting diversification success. As mentioned, much of the strategic focus and money has been spent on enhancing infrastructure. But this is actually one of the less pressing issues. On average, the GCC nations are among the top quarter globally when it comes to the quality of infrastructure, with the UAE deemed to be number four worldwide.

The assessment of the quality of training and education is generally less stellar. The results are indisputable: international comparisons of educational achievements in the fields of science and mathematics show GCC pupils performing at the low-end compared to strong global peers like Korea or Singapore.

A new Human Capital Index (HCI), unveiled by the World Bank at its annual meeting in October 2018, underscores the challenge ahead. A child born in Kuwait or Saudi Arabia today will be only 58 per cent as productive when she grows up as she could be if she enjoyed complete education and full health (with most of the weakness stemming from educational attainment). The findings for the UAE are somewhat better (66 per cent), but it, too, has a lot of room for catching up with its income level sovereign peer group.

Knowledge is the critical commodity of the future. Integrating nationals in ever larger numbers into competitive non-oil private sector jobs will be difficult without spreading knowledge, productivity and innovation more widely across the workforce. The subpar educational achievements in many GCC countries exacerbate another bottleneck to development and diversification, namely low labour participation rates among women. The low female participation rate cannot be explained by lower academic achievements. On the contrary: GCC girls outscored boys in the global harmonised tests more than anywhere else in the world. Ongoing initiatives to facilitate the integration of women into the workforce are therefore welcome.

All things considered, the emphasis on modernising infrastructure is appropriate and understandable. But without complementary reforms to enhance the quality of education and training and integrating the female labour force, the transformative effect of world-class physical infrastructure risks falling short of expectations.

Moritz Kraemer is Chief Economic Advisor at Acreditus, which is a member of The Gulf Bond and Sukuk Association.