New Saudi king should reform economy before it’s too late

Does King Salman have what it takes? Reuters

Ever since its unification as a nation state in 1932, the Kingdom of Saudi Arabia has been an oil-dominated economy. Most improvements and setbacks in its economic and social indicators can be invariably traced to the ups and downs of the oil market.

While that kind of volatility in revenues is unhelpful, dependence on petroleum would not ring too many alarm bells if it was sustainable. But it is not. Oil and the revenues it generates – 90% of all government income – will dry up at some point in the future, and the economy could collapse unless it diversifies.

That’s something King Abdullah bin Abdulaziz, who ruled the country for almost two decades until he died last week, was unable to do. His brother, Crown Prince and Defense Minister Salmam, has now taken over the throne and the reins of the Gulf’s largest economy.

Now King Salmam has the opportunity to accelerate the economic reforms promised by his brother but typically pursued at a snail’s pace, leaving the kingdom still almost entirely reliant on oil.

Will he take it? Unfortunately, the chances are slim, and political reform will be necessary first.

The late King Abdullah had many powerful friends. Reuters

An economy of oil

Saudi Arabia’s economic history mirrors that of the oil market, charting the rise and fall of a barrel of crude. It was robust from 1975 to 1980 and has performed well since 1999, but languished in between.

While most social indicators – such as literacy, access to good education and high-quality healthcare and higher life expectancy – have improved markedly, others have worsened, such as access to housing and employment.

The overriding economic challenge has been, and continues to be, expanding the private sector and diversifying away from oil. That’s a hard thing to do in a country with the world’s largest proven oil reserves and typically its biggest producer. In 2013, one in eight barrels produced around the world came from Saudi Arabia.

But implementing labor market reforms and institution building are necessary to fuel sustained economic growth and provide good jobs for the ever growing number of youths seeking employment and to protect future generations as the country’s oil reserves, however abundant, deplete.

Although the private sector has been growing robustly, it hasn’t expanded anywhere near fast enough to meet demand. And few of those jobs go to nationals. According to a 2013 IMF report, three-quarters of the 2 million jobs created in the previous four years went to foreigners.

Meanwhile, large swath of Saudis don’t have jobs, estimated at more than 30% for youths and women. And as for those who do work, 75% of them work for the government.

Unemployment may be the biggest danger for the regime.

An unfortunate dependency

The kingdom has made very limited progress on reforms under the administrations of the five kings that followed the rule of Abdulaziz Al-Saud, the founder and first monarch of Saudi Arabia, who presided over the discovery of petroleum in 1938. Reforms and progress have been more a mirage than real.

The government has implemented some domestic reforms such as cutting red tape, a jobseekers’ allowance and strengthened a quota system to increase the employment of nationals, according to the IMF. But they thus far have done little to get Saudis into the private sector workforce.

The recent slump in the price of oil highlights the need for the kingdom hurry up as the drop in revenue puts pressure on its sizable foreign exchange reserves, currently estimated at about US$750 billion.

This is particularly urgent: the Al-Sauds have become accustomed to throwing money at all internal and external problems and avoiding necessary reforms. The government annually spends upwards of $60 billion on fuel subsidies, $67 billion on military expenditures (fourth in the world) and many billions more in foreign aid to friendly rulers in Egypt and elsewhere. This approach is unsustainable.

To take just one historical example, foreign financial reserves were high back in 1980 but during the fallow years from 1981 to 1999, Saudi Arabia depleted much of them, forcing the country to resort to borrowing. It’s a stark reminder that reserves come and go, and the money will be best used to protect the interests of future generations by building up the private sector or establishing an external fund for future generations, a fund that is governed by transparent rules and policies.

Oil prices are expected to stay in the $40 to $60 a barrel range for at least the next five years due to weak global growth and an unwillingness by producers, including OPEC, to curb output. That will lead to widening budget and current account deficits, which will in turn erode the stockpile of reserves. This means the new king needs to act soon to turn things around.

The king is laid to rest after ruling the country for 20 years. Reuters

A time of turmoil

King Salman is taking over Saudi Arabia at a time of turmoil in the region and social challenges at home. Is he up to the task?

The Middle East is in the midst of unprecedented upheaval with conditions that are arguably more turbulent than at the onset of the Iranian Revolution. Saudi Arabia’s friends in the region, mostly the monarchies and dictatorships, are under siege. The Muslim extremists that the house of Saud encouraged with its vast wealth to counteract the Iranian revolutionaries beginning in the mid-1970s are ascendant. And they are not content to operate in the shadows but want to control the levers of power.

Iran also is resurgent at the same time as Saudi Arabia’s most important ally and supporter, the United States, is war weary after wasting too much blood and treasure in the region and appears willing to compromise with the kingdom’s adversaries. Saudi Arabia’s only potent international policy instruments – oil and the cash it brings – may be in perpetual decline.

Unfortunately, King Salman cannot do what Abdullah could not. Abdullah had widespread support in the Kingdom but moved very gingerly. Salman does not enjoy the same level of support, is in poor health and reportedly suffers from dementia. Moreover, Saudi Arabia is in the middle of an Arab world demanding a say in governance and crying out for social and economic justice. How long it can withstand political reform itself is a big question.

Family troubles and political reform

Making matters worse, Salman has already sown the seeds of family turmoil that will likely further limit his ability to pursue any meaningful reform.

Before Abdullah was even buried, he chose Mohammed bin Nayef, the interior minister and son of another brother, to be his deputy crown prince. That made bin Nayef the first family member from the next generation to be tapped to be a future king, a choice that was supposed to be made by a new 35-man council appointed by Abdullah.

These monarchical machinations only make the kingdom’s political and economic future grimmer.

Continuing autocratic rule in Saudi Arabia will fuel more extremism, instability, turmoil and revolution. The best defense against future turmoil and a path to sustained prosperity is a timetable for meaningful political reforms towards a constitutional monarchy.

If a true friend, the United States should use tough love and guide Salman to such an end.

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