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					Oil Dependency, Export Diversification and Economic Growth in

                                the Arab Gulf States

                        Sherine El Ha g a nd Mona R. El Shazly 2




Abstract

The standard argument in support of economic diversification to promote growth and

stability is put to the test for the Arab Gulf Countries (AGC). This paper shows that

although economic diversif ication reduces the risk associated with oil price volat ility

it raises exposure stemming from increased global integration. By testing empirically

the export composition of the AGC, we find that diversification and increased global

integration lead to robust economic growth as exemplified by the United Arab

Emirates. Though prudent, our findings show that t his strategy is not impermeable to

external shocks as verif ied by the 2007 global crisis.




   I.        Background

The Arab Gulf States (AGC) —Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the

United Arab Emirates— share many economic characteristics which include:


                A significant share of oil in GDP which accounts for about 75% of the

                 annual government revenues and exports.

                The region has about 45% of the world‘s proven oil reserves and 25%

                 of crude oil exports.

                The region depends on a large expatriate labor force offering workers

                 competitive wages.


        2
            Professor of Economics, Columbia College, S.C. melshazly@columbiasc.edu



                                                                                            1
               Labor markets are segmented by sectors, wages, benefits and skills.

               The governments of these countries have an extensive welfare system

                that provides a wide array of free or subsidized services to the people.

               The AGS established a sound banking system, and have pegged their

                currencies to the U.S. dollar.




The boom in oil prices over the past three decades significantly transformed the

region‘s landscape both socially and ec onomically. Oil proceeds by all six countries

were directed to building and moderniz ing the necessary infrastructure that would

support and sustain their planned economic growth. Reliance on oil export proceeds

however translated into increased vulnerability as oil prices proved to be extremely

volatile. This position was further exacerbated by the region‘s exposure to the

external shocks transmitted by the global economy.



In this paper we analyze the composition of exports for the six AGC over the perio d

1984-2007 to determine their degree of dependency on oil exports and correlate

them with the growth levels realized by each country. The structural reforms

adopted to achieve export diversification are described in section II with special

attention given to those of the UAE. In section III, the empirical analysis is

presented with a description of the measurements used to evaluate the linkage

between growth performance and export diversification. In Section IV the empirical

results are presented and discussed. The concluding section discusses the spillover

effect of the global crisis on the region and how it has precipitated Dubai‘s financial

meltdown.




                                                                                          2
      II.    Structural Re forms of the Ara b Gulf Countries



1) Re gional Overv ie w


In an effort to address the problems stemming from oil dependency and exposure to

external shocks, the governments of the AGC implemented reforms that resulted in

the diversif ication of their export structure. Of the six AGC, the United Arab Emirates

(UAE) took the lead in pursuing targeted policies that were aimed at reducing their

dependency on oil exports as shown in Figure 1.

                      Figure1. GCC Countries: Oil Depe ndency 1

                            (Average in 1998–2002; percent)




Sources: National authorities; and IMF staff estimates.

1
    Total government revenue includes invest ment income, and total exports include re-

exports.



                                                                                       3
Efforts toward regional integration have strengthened the ties between the member

states. The formation of the Gulf Cooperation Council ( GCC), which has been

underway over the past twenty years, has resulted in the freedom of movement of

goods, services, national labor, and capital. The main goals of the GCC include

strengthening the economic cooperation among their member countries, harmonizing

their economic and financial policies, developing the private sector, and achieving a

monetary union. The GCC countries share common characteristics; namely, heavy

reliance on hydro carbon, geographical proximity, small private and dominant public

sectors, heavy reliance on foreign labor force in the privat e sector, common

language and culture, and small populations except for Saudi Arabia that has about

70 % of the population of the GCC countries (Willet, Al-Barwanie, and El Hag, 09).




In November 1981, the GCC states reached an economic agreement as a step

toward full economic integration (Laabas and Liman, 2002). In 1982, they declared

their goal of forming a unified currency and although by 1983, a free trade zone was

established, it took over sixteen years to reach a custom union agreement in 1999.




In 2000, the GCC countries approved the use of a common exchange rate peg as a

step towards the formation of a common currency in 2010. In 2001, a joint custom

tariff of five percent was agreed on and enforced two years later. In 2002, the US

dollar was chosen as the intermediate peg before the common currency comes into

effect. In 2003, the GCC countries have adopted the customs union to lift all the

tariffs and other trade barriers among themselves (GCC.sg .org).


To further strengthen the ties between t hem, the groups of states harmonized the

banking sector, as well as permitted nationals to own real estat e and trade in

member states stock exchange. It was necessary however to revise the initial target




                                                                                        4
date of 2010 that was set for adopting a common currency and forming a monetary

union until the follow ing reforms were completed (Fasano and Zubair, 2003):


      Adopting a common code of fiscal conduct, consisting of clear criteria for fiscal

       convergence, a common accounting framework for public accounts, and

       adequate budgetary procedures.

      Determining a common exchange rate policy, including pooling of official

       foreign assets and the irrevocable fixing of bilateral conversion rates .

      Developing institutions, such as a common central bank, to support the

       monetary union, as well as a common set of instruments to ensure that

       monetary policy operations have a similar effect throughout the GCC

       monetary area.

      Establishing adequate data quality and common standards to assess progress

       toward convergence criteria and adherence to policy objectives .


Ongoing structural reforms and related macroeconomic polices are at different stages

of implementation in the AGC. Reforms at the state and regional level were directed

towards increasing non-oil export revenues so as to secure public expenditures and

growth performance. These reforms include: financial sector, foreign direct

invest ment, state enterprise and privatization, and the labor market (Fasno, 2003).


Reforms in the financial sector aimed at regulating the securities market, revamping

banking laws, and ensuring compliance on money laundering. Moreover, the AGC

took serious steps towards ratifying their invest ment laws by allowing foreigners to

own and trade shares on their stock market. Another key element in developing

their economies has been foreign direct investments. Because of their signif icant

role, it was vital for the region to implement strategies that would attract and secure




                                                                                        5
their operation. Free zones were set up by the UAE that were aimed at establishing a

hub for financial activity and a center for research and development.


Steps towards privatization and state enterprise reform followed the traditional trend

in which telecommunications, utilities, and transportation were at the forefront. The

government stakes in these sectors were gradually reduced through public sale

offerings. The framework adopted was gradual and regulated aiming to liberalize

public sector enterprises. The United Arab Emirates‘ approach encouraged joint

ventures with foreign investors.


Reforms in the labor market aimed at increasing the share of the national labor

force‘s participation in the private sector. Challenges faced by governments of the

region while different had to reconcile between necessary long-term structural

changes and short and medium term needs of the market. While it was necessary to

implement policies that enhance national labors‘ education and training,

governments had to contend with the increased pressure stemming from expatriate

workers who were readily available at competitive and flexible wages.




2) Economic Dive rsification


The AGC were successful in leveraging their oil revenues to fund projects in diverse

sectors. The chart that follows shows the different projects undertaken by each state

with their share by country and sector (Samba, 2008). The sector that dominates all

six states is construction which includes the building of new cities, real estate and

tourism projects, as well as establishing the necessary infrastructure to support the

governments‘ development plans. It is worth noting that the UAE led the AGC in

that sector with construction having a share of over 80% of all projects.



                                                                                        6
The UAE is a confederation of seven emirates: Abu Dhabi, Dubai, Sharjah, Ajman,

Ras El Khaimah, Umm al Qaiwain, and Fujairah. Each of the emirates has

incorporated its comparative resource advantage into its diversif ication strategy.

Abu Dhabi, focused on energy based industries, Dubai concentrated on its role as

commercial, telecommunications, and financial center in addition to becoming an

attractive tourist destination. Sharjah emphasized manufacturing while the northern

emirates specialized in agriculture, quarrying, cement and shipping (IMF Survey,

2002).




                                                                                      7
The strategy that the UAE adopted rests on liberalization of the economy, invest ment

partnerships, and diversification of income stream. External trade played a

significant role in the country‘s economy as exports and re-exports grew follow ing

the establishment of the free zone areas and the adoption of successful trade

policies. Recent data shows the growth and composition of foreign trade which in

2007 reached 157% of GDP (UAE Annual Report, 2007).




The economic expansion which the UAE experienced paved the grounds for

improving and building the different sectors, namely: education, tourism,

construction, and the housing sectors. Trade has played an important role in

shaping the economy. While oil and oil related products have always been credited

as primary exports, the UAE expanded its export base to include a wide range of

highly sophisticated products and services. The UAE‗s experience asserts that it is

not how much you export, but what you export that matters. This premise is put to

the test in the section to follow for the AGC.




                                                                                      8
    III.     Empirical Analysis




To empirically test these conceptual ideas, we apply Ricardo Hausmann and Dani

Rodrik‘s recently developed indicator, PRODY to the AGC. The index is estimated by

calculating the weighted average of the incomes of the countries exporting a

particular product, where the weight s are the comparative advantage of each

country. The weights are used to ensure that country size does not distort the

ranking of goods. ―By using export share rather than export volume, the weighting

scheme tries to ensure that adequate weight is given exports that are important to

smaller poorer countries‖ ( Rodrik,06). 1



For a given year, total exports of country j are given by the following: Xj=

where countries are represented by j and goods are indexed by l. Let the per-capita

GDP of country j be denoted by Yj. Hence, the PRODY index for good k can be

calculated as follows:

PRODY k = Σ [ (xjk ) / Xj ] / Σ (xjk ) / Xj * Y j

The numerator of the weight (xjk / Xj) is the value-share of the commodity in a

certain country‘s total exports. The denominator of the weight, Σ (xjk ) / Xj ,

aggregates the value-share across the countries exporting the product.

The average PRODY from 1992-2007 is used to construct an EXPY measure for all

the AGC during this period of time. EXPYi measures the productivity level associated

with a country‘s export basket. In other words, EXPY is the weighted average of the

PRODY for each country, where the weight represents the share of each commodity

in that country‘s total exports (Rodrik, 06).




1
 A detailed analysis of EXPY and PRODY is shown in Rodrik’s paper “What’s So Special About China’s
Exports?”


                                                                                                     9
EXPY for country i is given by the following equation:

Σ (xjk ) / Xj * Prod Y


To estimate PRODY and EXPY, we have collected the trade data for the AGC from the

United Nations Commodity Trade Statistics Database (COMTRADE). The value of

exports is measured in current US dollars. The source of the Real GDP per capita

data is obtained the Penn World tables and is used to estimate the PRODY measure

for the GCC countries for each year over the period 1991- 2007 using 3- digit level of

classification. The data set includes about 329 commodities for each of the se lected

countries and is used to construct the PRODY and the EXPY index over the period

under study.2




    By examining the data, we find that the income level associated with individual

traded commodities varies greatly. This reflects the fact that specialization and

product diversification are highly dependent on per-capita incomes. As predicted,

items with low PRODY tend to be primary commodities (oil being an exception).




      IV.      Re porting and Analysis of Results

The results obtained allowed us to compare the progress over time of UAE‘s EXPY

with that of the rest of GCC countries. The trend for EXPY over the period understudy

reveals that the UAE experienced the most rapid rates of growth in its exports

relative to those of the other GCC countries (UAE, Kuwait, Saudi Arabia, Oman,

Qatar, and Bahrain). This may be attributed to the diversification of its exports

relative to the rest of the GCC countries. It is also worth noting that there were

many quality differences within the 3-digit products code. The data shows that




2
    We’ve inserted zeros for the missing data regarding certain goods.


                                                                                     10
compared to the GCC, the UAE‘s invest ments focused more heavily on construction

and tourism.


The findings reported in Table 1 and Figure 1 support the claim that there is a

positive relationship between EXPY and growth experienced by a particular country,

while holding initial levels of income constant.

                                         Table 1

                             UAE’s Rea l GDP and EXPY

                           year          real GDP   EXPY

                                  1999   25266.91   21480
                                  2000   32246.91   25936
                                  2001   32631.56   25887
                                  2002    31598.3   25602
                                  2003   34931.26   28401
                                  2004   39509.84   32627
                                  2005   47249.02   39135
                                  2006   53495.91   44633


Source: PEN World Tables for real GDP data
and the authors‘ computation for EXPY

                                         Figure 1




Source: PEN World Tables for real GDP data
EXPY is computed by the authors



                                                                                  11
It is also interesting to compare the trend of UAE‘s EXPY with that of other GCC

countries for the period under study. Our analysis, as shown in table 2, reflects that

the EXPY for UAE has been the highest compared to Saudi Arabia, Bahrain, Kuwait,

Oman, and Qatar. ―While the productivity of a country‘s export s is determined in

part by its overall productive capacity and its human capital endow ment,

idiosyncratic characteristics also matter‖ (Rodrik, 06). For example, Saudi Arabia

that has similar factor endow ments—abundant in capital, expatriate labor, has a

lower EXPY than that of UAE. It is evident that the peculiar features of diversification

caused the UAE to enjoy high level of EXPY which fueled their economic growth.

                       Table 2: EXPY for the GCC Countries


             Bahrain       Kuwait       Oman       Qatar       Saudi Ara bia       UAE
     1990              0   16860.63     16742.63   17464.43           16727.55             21727.81
     1991              0   15926.98     16163.76   16928.43           16338.12             24187.23
     1992              0   17658.27      17316.7   18012.72           17043.89             23814.86
     1993              0   17696.36      16944.3   17708.19           16955.88             21326.34
     1994    15689.29      16489.72     15438.36   16465.94           15650.39                 0.00
     1995    15490.79      16917.78     15815.54   17261.96           16135.84                 0.00
     1996    16366.94      17854.93     15224.03   17910.93           16304.84                 0.00
     1997              0   21759.26            0           0                0.00               0.00
     1998              0   14957.39            0           0          13449.57                 0.00
     1999              0    18240.4            0           0          16898.41             21479.53
     2000    19140.19      22877.55            0           0          19444.95             25935.82
     2001    18974.08      21142.65            0           0          18712.20             25887.37
     2002      18969.1     22664.19            0           0          18646.86             25601.74
     2003    20502.51               0          0           0          20468.77             28401.08
     2004    22110.69               0          0           0          22684.77             32627.16
     2005    26504.48               0          0           0          27032.23             39134.54
     2006    30159.21               0          0           0          29888.12             44632.81
     2007             0           0           0            0                0.00           57259.23
Source: Based on the computations of the authors.
Note: All the zeros represent the missing data.




                                                                                     12
It is also worth noting that identifying a high productivity in an exportable good

would attract more invest ments in those sectors. This in turn would reallocate

resources away from lower productive activities into higher productive activities

(Rodrik, 06). This type of growth driven by differential productivity rates across

sectors is apparent in the UAE. Hausmann and Rodrik (2003) further suggest that

successful new industries often exist for ―idiosyncratic reasons‖. We argue in this

paper that specializing in some products or services together with diversification will

generate higher growth rates than specializing in others. This argument is supported

by our computation of the PRODY and EXPY for the GCC countries. Our evidence

supports this argument and proves that some traded goods are associated with

higher productivity levels than others and help countries to grow faster than others.

Some high-growth countries such as UAE have EXPY levels that are much higher

than the other GCC countries. Hence, if the UAE has exported only those products

that countries at UAE‘ level of income tend to export, or to focus on oil related

products, its growth rate might have been much lower.




The study finds that the rise in UAE‘s EXPY level over time is largely accounted for by

its export diversification as well as the changing of its export structure away from

low to high productivity goods. As such, we surmise that productivity diffusion

within the UAE has generated positive spillovers on all sectors of the economy as

labor and other resources shifted into the production and exports of those goods and

services that are more sophisticated.




                                                                                       13
   V.      Concluding Remarks


The pursuit of a comprehensive reform strategy to reduce vulnerability stemming

from volatile oil revenues proved to be a prudent strategy for the UAE. As this paper

shows, diversification and shifts in export structure away from low to high

productivity goods did indeed accelerate the UAE‘s rate of economic growth relative

to the AGC. By redirecting resources into construction, real estate and tourism, the

UAE became more integrated in the global economy and as a result found that it was

not impermeable to external shocks.


Attesting to this reality is the sub-prime mortgage crisis that began in the USA two

years ago yet reverberated around the world and led to the burst of housing bubbles

in places as far as Britain and Iceland. Dubai, which has heavily invested in real

estate, saw its construction dream transformed to a night mare. In December 2009,

Dubai was forced to expose its fragility and admit that the collapse in property

values rendered their collateral to fall short of the billion of dollars debt that they had

accumulated (Roberts, 2009).


While diversification reduced the risk of oil revenues it increased exposure to

external shocks. The global financial crisis did not spare the UAE. Reverberations

were strong enough to cause turbulence in the neighboring countries that supplied

the Gulf countries with their workforce. As real estate prices plummeted and tourism

declined many foreign workers from poorer countries were forced to face and adjust

to new realities. This translated to bad news to countries that relied on remittances

adding to their economic woes.



For the north African and Mideast countries, where chronic economic stagnation, high

unemployment and low-paying jobs have long plagued their labor force, returning



                                                                                        14
workers from the Gulf rich countries only exacerbated their f rustration. According to

World Bank estimates, remittances declined for the first time in a decade by more

than 7% in 2009 (New York Times, 2010).




Despite the serious challenges that the UAE is facing, it is adamant in overcoming

them and is intent on showing the world that it has not been detracted from its

construction boom. The grand opening of the world‘s tallest skyscraper ―Burj

Khalifa‖ in the midst of the crisis is a testimony to their resolve.




                                                                                     15
                                    Re fere nces


Amba Financial Group, ― GCC Economic Outlook‖, Office of the Chief Economist, June
2008.


Barley, Richard, (2009). ― Dubai‘s Breathing Space‖ . The Wall Street Journal, Dec
15.

Dan Roberts, ―Castles in the Sand‖, guardian.co.uk, Friday 27 November 2009.

Gulf Research Center (2005), ‗Co-operation Council for the Arab States of the Gulf
(GCC Charter)‘ www.gulf inthe media.com Sept. 15th.

Hausmann, R., Hwang, J., Rodrik, D.: What you export matters. NBER Working
Paper no.11905, December 2005.

Lall, S., Weiss, J., Zhang, J.: The Sophistication of Exports:A New measure of
Product Characteristics.QEH Working Paper no.123, January 2005.


Laabas, B. and I. Limam (2002), ‗Are GCC Countries Ready for Currency Union?‘
Arab Planning Institute – Kuwait, April.

Prosser, David (2009). ―Dubai slides further into financial crisis‖. Thursday, 26
November 2009. Retrieved
fromhttp://www.independent.co.uk/news/business/comment/david-prosser-dubai-
slides-further-into-financial-crisis-1827597.ht ml

Rodrik, Dani, .What.s So Special About China.s Exports?.China & World Economy,
vol. 14. no. 5, September-October, 2006, 1-19.

Rose, Andrew K., "Size Really Doesn.t Matter: In Search of A National
Scale Effect," NBER Working Paper No. 12191, April 2006


Ugo Fasano and Zubair Iqbal, ― GCC Countries: From Oil Dependence to
Diversification‖, International Monetary Fund, 2003.


http://www.dubaichronicle.com ―UAE Economic & Strategic Outlook‖, Posted By
admin On April 21, 2009.



The Associated Press, ―Dubai Dow nturn Sends Ripples Throughout Arab World‖, New
York Times, January 7, 2010



The Times Online November 27, 2009 ―Dubai in deep water as ripples from debt
crisis spread‖




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The Economist Print Edition (Risk after Duba i). ―When sovereign doesn't mean safe‖
Dec 3rd 2009. Retrieved f rom
http://www.economist.com/displayStory.cfm?story_id=15017205 )


Tom Hundkley ( 2009). Dubai, Financial Crisis Looms. Global Post
Monday 14 December 2009.
Washington's Blog ( 2009). ―Financial Crisis: Dubai Bubble Burst‖
http://www.globalresearch.ca/index.php?context =va&aid=16328.

 Whitney, Mike ( 2009). ―Financial Crisis in Dubai: Towards a Night mare Scenario?
Global Research, Nov 28




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