Saudi Arabian Economy: Economic Crisis?

The economy of Saudi Arabia is a great example of what happens when you fail to adjust your economy quickly enough to shifting economic sands. Having started an oil price war in March 2020 by increasing supply at a time when demand was crashing, this inevitably led to an oil price crash. In doing so, Saudi Arabia has encountered a bit of a problem. An oil price below the magic $76 threshold required for the state to balance its budget. It's impossible to make any meaningful economics video about the Saudi economy without at least starting with oil, though what many people don't know is that the kingdom owes its wealth to the discoveries of Max Steineck. You see, back in the 1920s and 30s, Saudi Arabia, like most of the Gulf, was a largely impoverished land. According to the book Heart of Arabia, a book written a decade before Saudi Arabia was even a unified country, the future king had only $4,000 in his treasury, a far cry from the $1.4 trillion the royal family is estimated to have today, equivalent to 16 times the wealth of the British royal family. The fate of the desert kingdom changed when Max decided to search for oil in a place called the father of sandflies, using a revolutionary technique called structure drilling. The Saudi economy had struck gold, well black gold at least. It's impossible to overstate just how important this was to the Saudi economy, the energy leverage it gave it and how it changed its perception of itself and how the world saw it. So, what's the Saudi's economic model? Many economists would classify the Saudi economy as operating a rentier state-like model. What's a rentier state? An economy which receives on a regular basis substantial amounts of external rent. Rentals being payments by foreign countries, businesses or individuals. In Saudi Arabia's case, rents are paid for its oil. You see, oil makes up around two-thirds of the kingdom's exports, making the nation the world's largest oil exporter. But, not the country with the largest reserves, that title goes to Venezuela. This literal flood of oil money helps explain how 87% of the state budget is derived from oil, a disproportionately high percentage of revenue from one source. And this revenue is largely funnelled through the state oil company, Saudi Aramco. As you may recall, Aramco made international headlines when it went public in 2019, raising $26 billion, though what you may not know is that this vast sum was only by selling an estimated 1.5% stake in the oil giant. Which gives you an idea of just how valuable Aramco is and in turn how important it is for the government, providing a sizeable chunk of government revenues through one company. Now you may be wondering, what has the government been doing with this windfall of petrodollars? Well, this is where the Saudi's unique economic model really shows. Public expenditure is the key driver of the economy. The Saudi royal family, an inseparable part of the state, is a key beneficiary of public expenditure. With over 15,000 members, spending is vast. Whether that be a $450 million Da Vinci painting, a 500 million yacht or a 300 million French chateau. Though public expenditure goes far beyond Da Vinci's and Ferrari's, it forms a crucial part of the social contract between the state and its citizens, whereby citizens enjoy state subsidies and handouts in return for loyalty. For example, an estimated 67% of Saudi citizens are employed in the public sector, where the average wage paid to Saudi nationals has exceeded that in the private sector in recent years. Now whilst this may sound great if you're a Saudi national, it presents a huge challenge for the Saudi economy, which we will be delving into a bit later on. Now you may be thinking, if 67% of Saudi nationals are employed by the state, who runs the private sector? Well, like many other Gulf states, this is filled largely with foreign workers, in pretty much all sectors. For example, of the 1.5 million retail jobs in the kingdom, only 20% were filled by nationals. And crucially, as you'd expect with such a high proportion of foreign workers, comes a high level of capital outflows, as expats send money out of the country. This has resulted in Saudi Arabia having the third highest level of outgoing remittances in the world. Though, there is also an important segment of the labor force missing, women. Whilst Saudi Arabia has made some progress in women's rights, especially under Crown Prince Mohammed bin Salman, deep structural flaws remain when it comes to gender. The participation rate of women in the economy was only 26% in 2019 according to the World Bank, with female unemployment, that is to say, those women actively seeking work, running 5 times higher than men. So with that background, why is too much of a good thing a curse? This really boils down to how wealth is managed, and the impact it's allowed to have on your wider economy. If you imagine a spectrum of On the one hand, you have economies like Norway, who have effectively managed their oil wealth, through sovereign wealth funds, savings, and offshore investments. On the other hand, you have the extreme example of Venezuela, which despite having the world's largest oil reserves, according to OPEC, allowed oil to completely swallow its private industries. Saudi Arabia sits somewhere between the two. The major risk for any commodity economy, is the so-called Dutch disease, stemming from when the Netherlands discovered natural gas reserves in the North Sea. This basically entails a large commodity wealth, leading to inflows of money to extract resources, which crowds out other local industries and causes exports to become more expensive, resulting in rising imports and a less diversified economy. The Saudi government faces another challenge from its oil wealth, how to manage its budget when the main revenue source is subject to extreme revenue volatility. Oil prices in 2020 have dropped from over $60 a barrel to $25, a 60% swing. For state economic planners, this presents a huge problem. When prices rise, higher revenues often lead to an increase in government spending, boosting activity in the non-commodity sector of the economy. All this money means asset prices and credit is likely to move in sync with commodity price cycles. Confidence increases and consumers and businesses alike spend. But, as with any cycle, when commodity prices fall, the economy quickly reverses into a downturn. When dealing with something as volatile as oil, this can hamper sustainable long-term development of the wider economy. For Saudi Arabia, high levels of public expenditure make its economy particularly susceptible to the commodity cycle. A perfect example of this is vehicle sales. Since the last big oil drop in 2015, vehicle sales have declined by over 50%, despite a growing population. Now, as mentioned earlier, high levels of state expenditure pose a huge problem. Generous state wages act as a disincentive to strike out into the private sector, which is meant to be the economy's engine room for innovation, whilst the share of non-state economic activity has grown. A lot of this has been as either a consequence of public sector investment or to serve the nation's oil industry, making structural diversification, away from public spending and oil, a huge problem. One which is increasingly compounded by a relatively new concept to the kingdom. Austerity. In the face of falling oil revenues and large deficits, the state has been forced to tighten its belt. Public debt has risen from less than 5% in 2014 to over 25%. This is starting from a relatively low base, but rising rapidly. And you've got to remember, in the past, Saudi Arabia was known for low to no taxes. Even in 2018, when Radia introduced a VAT tax and reduced fuel subsidies, the economic hit was dampened through the introduction of a cost of living allowance for over 1 million public sector employees at 1,000 rials or $267 per month. But light touch austerity simply hasn't worked, with recent austerity measures scrapping the allowances, saving an estimated $4.6 billion a year, and trebling VAT to 15%. A shock to the system which implies the economy will have to live more within its means from here on in. So what's the Saudi solution to its economic woes? Essentially, the kingdom has three distinct goals. Revolving around developing its economy, stabilising it against oil shocks, and ensuring future generations benefit from its non-renewable wealth. To achieve this, the kingdom has launched Vision 2030, spearheaded by Crown Prince Mohammed bin Salman. The core aim is to help the kingdom wean itself off oil dependency like other Gulf nations have, by playing to its strengths. For example, the nation is already a tourist hub through religious travel, though the kingdom wants to dramatically expand the scope of this tourist sector, attracting leisure-seeking tourists through amusement parks and holiday resorts, aiming to increase tourism from 65 to 100 million a year by the end of the decade. And on the third point, about ensuring the nation's wealth is around for future generations, long after the oil has gone, the kingdom's strategy is to increasingly rely on its sovereign wealth fund, the Public Investment Fund. The fund has been increasingly active, with assets over $390 billion, buying up stakes in Facebook, Google, and a failed takeover bid of Premier League team Newcastle United. Now whilst this is all good and well, the challenge the kingdom faces has another dynamic though, a demographic one. You see, Saudi Arabia has a young population. Its population has increased by almost 75% since the turn of the millennium. In the context of the nation needs jobs, and so far a lot has been invested in education, though with each new degree comes a higher expectation, an expectation of a diverse job market. Though the reality is that 50% of the jobless are graduates, over-skilled and unemployed. The kingdom's solution to this is for the Saudiisation of the labour force, with an ambition to replace foreign workers in key sectors with local labour. And of course, this makes the need for a diversified economy a necessity, especially in an era of cuts to the cost of living subsidies and higher taxes. Though how does all this compare against the successful strategies other countries have used? If we were to take a step back and look at what's worked for other countries, we would see a number of common themes in achieving diversification. Ultimately, these revolve around putting incentives in place to develop export markets and support local workers to gain the skills necessary to take on these opportunities. According to the IMF, attraction of foreign direct investment is crucial, alongside technology transfers, the development of human capital, and the support of small to medium-sized enterprises. Now, whilst reports show that foreign direct investment and the share of non-oil-related output has risen, there is still concern that this is almost too little, too late, to stave off the painful measures the kingdom will now have to implement. So overall, the Saudi economy operates a rentier-style model, being heavily dependent on an oil wealth which has been both a blessing and a curse. State dependence on oil revenues is reflected in the high proportion of public expenditure which drives the economy and export earnings, with a reliance on foreign workers to fill many of its voids. And it is this dependence which poses a fiscal challenge to managing the Saudi budget given the volatility of oil prices. To counter this, the state is trying to diversify and stabilise itself from oil price shocks, primarily through the flagship Vision 2030 programme, the latest in a long line of attempted reforms. Though whether this is too late to avoid the harsh measures necessary in an economy and world post-oil remains to be seen. Now, we want to hear what your thoughts are. Do you think the economy of Saudi Arabia is at a crossroads? Will Vision 2030 be a success? Let us know in the comments below. The AltSimplified team hope you've enjoyed this video, and if you did, please consider hitting that subscribe button. It really helps grow this channel. And as always, see you in the next video.