Oil prices, authoritarian bargains, and reform opportunities in the Gulf States

The OPEC meeting in Vienna has just concluded without a production freeze deal. Oil prices—which prior to the meeting had risen above $50 a barrel (an important “psychological” milestone and a 50 percent increase since the low of February 2016)—fell about 2 percent following the announcement.

As the famous film producer Samuel Goldwyn once said, “Only a fool would make predictions—especially about the future.” Yet oil prices remaining below their fiscal break-even points are posing a unique challenge for the oil- and gas-rich Gulf Cooperation Council (GCC) countries. They also present a once-in-two-decades opportunity for these governments to reform and diversify their economies. High oil prices have powered the GCC’s rapid growth for almost two decades. Since the end of 2014, revenue losses have put significant pressure on the prevailing mode of governance, one that involves significant welfare channeled to citizens through the public sector combined with a highly segmented labor market.

Naturally, the GCC does not face the same types of crises compared to its poorer fellow OPEC members. Last year, Angola slashed its public investment budget by more than one-half; some have argued that cuts to waste and sanitation, in particular, may have triggered a yellow fever epidemic. In Ecuador, the government has garnished wages of those in the public sector earning more than $1000 per month. In April, Ecuadorian President Rafael Correa began talks with the International Monetary Fund (IMF) and World Bank—whose resident representative Correa famously expelled at the start of his first presidential term in 2007. Revenue losses have dramatically affected Iraq and Libya’s capacity to fight Islamic State. In Nigeria and Venezuela, revenue losses from plummeting oil prices have contributed to economic crises not seen for over two generations: Public services are collapsing; mortality rates are rising; multinational corporations have withdrawn (several international airlines have suspended operations to both countries); and both countries are struggling to defend their fixed exchange rates.

But in the GCC, the oil glut has forced governments to think the once unthinkable: cuts to public benefits and the T-word—taxation. In the GCC, the public sector provides citizens with higher wage and benefit packages and better job security than the private sector. Opinion polls in the GCC routinely show that between 60 and 80 percent of GCC citizens prefer low-productivity, high-paying government jobs to working in the private sector (or being self-employed). Meanwhile, the private sector is dominated by family businesses, where low-wage and low-skill employment is taken up by migrants. Even as private investment has increased, firms have continued hiring expatriate workers, who generally have lower wage expectations, require less training, and are subject to more flexible labor market regulations. As a result, economic growth in the region has mainly been due to factor accumulation and little due to gains in productivity. Moreover, despite policy efforts to nationalize labor forces, segmentation of the workforce by nationality—with the public sector dominated by nationals and the private sector dominated by foreign workers—has persisted.

The relationship between oil wealth and dictatorship is well known. There are 14 countries with a per capita income above $15,000 (PPP-adjusted) that are classified as dictatorships by the Polity IV score. Of these, 11 are oil- or gas-rich countries. Dictatorships—even the most repressive—require some form of legitimacy to survive. By the authoritarian “bargain,” autocratic states restrict political rights while aim to provide welfare necessary to avoid challenges to their rule. The story of reform in the GCC is that, when oil prices are low, governments make meager gestures towards enhancing the political franchise. During the last period of low oil prices (1990s) Kuwait—the only GCC country considered by the watchdog organization Freedom House to be “partly free”—held its first multiparty parliamentary elections in which opposition parties participated. Around the same time, Saudi Arabia held its first municipal elections, and Qatar granted women the right to vote. When oil prices rise, leaders can use their state’s wealth to secure their rule. In the aftermath of the Arab Spring in early 2011—at a time when oil was over $100 per barrel—Saudi Arabia, Bahrain, and Qatar increased salaries for civil servants, military, and internal security forces. At the same time, all three countries cracked down on dissent or suspended political liberalization efforts (Qatar cancelled what would have been its first parliamentary elections). Thus observers have likened political cycles in the Arab world to a pair of political lungs, “breathing in… and expanding, but then inevitably exhaling and contracting when limits are reached.”

The relative economic wealth of the oil-exporting, labor-importing GCC countries has provided a stronger buffer against revenue losses compared to the resource-poor, labor-exporting countries of the Middle East and North Africa. Now the plunge in oil prices is pushing the GCC countries to draw down their reserves, go into fiscal deficit for the first time in over a decade, and implement various types of austerity. They have begun to make cuts to subsidy programs—including fuel subsidies—and have discussed the option of a GCC-wide, value-added tax. IMF Managing Director Christine Lagarde, among others, have pressed the Gulf States to cut spending.

Ultimately, it will fall to reform-minded GCC leaders to take advantage of what may be a brief window of opportunity to push for diversification. There are hints of movements in that direction. The emir of Qatar, Sheik Tamim bin Hamad Al Thani, has warned that the state will no longer be able to “provide for everything.” Saudi Arabia’s Vision 2030 foresees a kingdom no longer reliant on oil. These are important steps, but of course, will require a major political reorientation of Gulf-state governance. Blueprints for economic diversification, based on the experience of countries that opted for similar reforms, are widely available.  

But more critically, and far more difficult to achieve, will be the need for GCC rulers to stop fearing the rise of a truly independent merchant class—one that has achieved its wealth through entrepreneurship and hard work, rather than through transfers from the state, through royal birth, from membership in the inner circle of the rulers, or through some other forms of advantage or privilege. Equality of opportunity and diversification are the two sides of the same economic coin.