Editor’s Note: Djavad Salehi-Isfahani recently spoke on-air to 6 News, a Turkey-based TV channel, about how oil-exporting economies in the Middle East will cope with the economic downturn. If oil prices remain low over the course of the next year, economies such as Iran and Iraq will face pressure to implement fiscal adjustments more quickly, while other countries in the region, such as Saudi Arabia and the United Arab Emirates, may be able to compensate by drawing on large foreign reserves. An edited transcript of the interview follows. This comes as a continuation of our earlier series: “Food, Fuel, and Finance: How Will the Middle East Weather the Global Economic Crisis?”.
Laura Wells (Anchor): Here to take stock of the Muslim world’s economies is Djavad Salehi-Isfahani, guest scholar at the Wolfensohn Center for Development and professor of economics at Virginia Tech. Thank you for joining me, Dr. Salehi-Isfahani.
Djavad Salehi-Isfahani: My pleasure.
Wells: So, how would you rate the economies of the Middle East in terms of today and their potentials relative to the rest of the world?
Salehi-Isfahani: Well, there are really two kinds of Middle Eastern economies: there are the oil-rich countries that have very high per-capita incomes in excess of 20 or 30 thousand dollars per person and then there are poorer countries, like Yemen, for example. So there are both underdeveloped countries in the Middle East and rich, but not-so-developed countries. We are now in a position to get a bit more of a level-playing field; because of lower oil prices those super-rich countries are going to become perhaps much less rich than they were before.
Wells: A lot of economies are ranked by, for instance, something such as an educated workforce. How does the Middle East rank according to other parts of the world in terms of what kinds of employees you can find there?
Salehi-Isfahani: Actually, it fares relatively well. The Middle East is more educated than the average [in] developing countr[ies]. Some would say they are over-educated because you have a lot of young people who have high school and college degrees, but don’t have jobs. This is especially true in the Persian Gulf countries where education is a way of joining the government labor force, so a lot of young people have gone into government but there are not enough jobs for them.
Wells: Is that potentially a problem, that perhaps the potential workforce is too educated?
Salehi-Isfahani: Well, it is both an opportunity and a problem. It is an opportunity in the sense that these people have some very basic skills that can be tapped, but it is a problem at the same time because they are all relatively disappointed. They worked very hard to get these degrees often passing very difficult tests and when they get to the labor market they have to wait a long time. If you compare the waiting time of a typical high school graduate, or a college graduate, in the Middle East — say Egypt or Iran — and compare it to Latin America, you find out that whereas in Latin America the typical young person waits a few months to find a job, in the Middle East it’s two to three years. This creates a condition of hopelessness among the young, and in an economic downturn, this could be potentially politically destabilizing.
Wells: Let’s change gears and talk about the main natural resource in the region: oil. The price has fallen to less than half of what it was last year: it has fallen to under 40 dollars a barrel even two days ago. OPEC vows to soon decrease output to boost prices later this month, but where do you see the price of oil going in the next year?
Salehi-Isfahani: I actually don’t see any potential for an increase. If you look at OPEC’s ability in the past to raise prices in a weak market, it has not been so successful. So when the price of oil declined in the 1980s, precisely in 1986, it took a long time before the demand caught up with excess capacity and oil prices started going up, and OPEC played virtually no role. And as then, OPEC is unable now to do very much about the falling prices. I think prices are likely to fall further if demand from East Asia weakens: East Asia and India. Their economies are still growing, unlike the ones in Europe and United States, so if the demand from these large developing countries that are continuing to grow weakens because their growth stops, you probably could see oil prices in the thirties, even in the twenties [USD per barrel]. I think developing Middle Eastern countries ought to brace themselves for a further decline and not sit there hoping prices might jump back up to 70 or 80 dollars.
Wells: When might we see this 20 or 30 dollar barrel of oil?
Salehi-Isfahani: It depends if, and how quickly, the Chinese economy comes down. You know, it is possible that it will keep growing through the crisis, but it is also possible that its growth will stop. If that happens, I would say within a year, you might see prices falling further: falling down to the level of 30 dollars and perhaps even below.
Wells: If the price of oil continues to be depressed, as you say it well might be, what could happen to [oil-exporting] economies? Will they run deficits or could they potentially go bankrupt? Also, what sort of ramifications would it have for the residents, and perhaps even the governments?
Salehi-Isfahani: Well, economies don’t go bankrupt. They perhaps will experience harsh adjustments to lower oil revenues, a bit like a family whose income drops, they will have to cut back on consumption. I think these countries differ with respect to how difficult it is going to be for them to adjust. I don’t think the United Arab Emirates is going to have much of a problem; they have a lot of reserves — foreign exchange reserves — and so does Saudi Arabia. Saudi Arabia probably will be okay for another couple of years. But for a country like Iraq [or] Iran, they are going to be in a very difficult position. Iranians were barely saving $10 billion a year when the price was around 100 dollars [per barrel], so …now that the oil prices are down to 40 dollars [per barrel] and their oil income is down by more than half, they are facing two large deficits. One in external trade: Iran, for example — I am more familiar with Iran, so that’s the example I use — imported about 70 billion [USD] this past year, and next year they probably won’t be able to import more than 50 [billion USD], even with some borrowing. The [second is] domestic balance: the government is going to have a big shortfall. So, they will run a budget deficit; I think that probably will happen.
[In] most of these economies, their governments will run a budget deficit and an external trade deficit. The difference is in how they manage those deficits: how they finance it. As I mentioned, the UAE and Saudi Arabia will probably finance it by drawing down on their reserves. Other countries may have to go borrow and, as you know, borrowing these days is not easy. All the rules have changed, a lot of financial institutions in the West are unable to operate the way they used to. So there is a bit of uncertainty there about whether these countries can finance this downturn through foreign borrowing and hope to pay it back later.
So, they may have to really come down hard on the brakes, which is to limit imports, and wages will drop and people will suffer. If I might add, depending on what kind of social protection system they have — how well they take care of their poor — you might see suffering at the lower end of the income distribution or you may see suffering at the middle level, with the middle class taking a big hit.
Wells: Well, since oil is maybe the biggest sector in some of these countries, and certainly the biggest export in these countries, could we see new industries developing?
Salehi-Isfahani: That’s a very good point. The silver lining in this sort of downturn is that … tradeable industries, including agriculture by the way, that suffer when there is a huge inflow of foreign exchange — they can rebound, they can revive. You know the textile industries in most of these countries, for example, some of them are small and some of them are large, they are practically getting wiped out because of cheap imports from China, paid for by abundant oil revenues. When these revenues stop and imports stop or shrink, domestic industry has a better chance to compete. Now, if the economies are flexible, then people can switch jobs and go work in these new industries: you might see a boom in one sector as another sector is declining. But if the economies are very rigid, then that may not happen in the short run: all you will see will be declines in employment and real wages.
Wells: A lot of your research is focused on Iran: how is the country doing now, and how does its future look?
Salehi-Isfahani: …We have a presidential election coming up in June, and the government seems intent not to allow the financial crisis in the world and in the oil markets to affect the domestic economy. Basically they are carrying with business as usual, importing and spending, and I think they are really postponing the problem until after the election. So, it is sort of a political move.
But after the election, after June, the economy is going to have to face much lower oil revenues, less than half of what it used to be last year. If experience means anything, they will probably do import restriction. They will cut down on imports: last time they had a problem like this about ten years ago they restricted imports by 50 percent, so that could happen. They will probably do some borrowing: Iran is in a reasonable position to borrow, since it doesn’t have a lot of overhang of large foreign debt. In fact, it has very little foreign debt. The key question is whether they would allow the exchange rate to adjust to limit the imports, or whether they will simply prevent imports from coming in and try to manipulate the exchange rate. If they do the latter, they will be going back on some of the economic reforms of the 1990s; that is going to make the economy a lot less flexible and a lot less capable of dealing with these adjustments.