Why the Saudis will either blink…or collapse

As Saudi Arabia`s budget has come under pressure from low oil prices, I see that the Kingdom (KSA) has announced a diversification initiative into IT, healthcare and tourism (via CNBC):

Saudi Arabia outlined ambitious plans on Monday to move into industries ranging from information technology to health care and tourism, as it sought to convince international investors it can cope with an era of cheap oil.

A meeting and presentation at a luxury Riyadh hotel was held against a backdrop of low oil prices pressuring the kingdom’s currency and saddling it with an annual state budget deficit of almost $100 billion – the biggest economic challenge for Riyadh in well over a decade.

Top Saudi officials said they would reduce the kingdom’s dependence on oil and public sector employment. Growth and job creation would shift to the private sector, with state spending helping to jump-start industries in the initial stage.

“It’s going to switch from simple quantitative growth based on commodity exports to qualitative growth that is evenly distributed” across the economy, said Khalid al-Falih, chairman of national oil giant Saudi Aramco.

The competitve advantage of nations

What KSA faces is a classic problem in development economics. How do you create new industries and employment in an economically depressed region?

For that answer, I turn to Michael Porter, the author of The Competitive Advantage of Nations, and Jane Jacobs, whose work included The Economy of Cities and Cities and the Wealth of Nations. Porter`s analysis is more businesslike and his analysis was at the national level, while Jacobs was more academic while her unit of analysis was the city-state, but the message was the same. Porter`s framework of how countries moved up the value-added chain is highly instructive, with examples like Japan and South Korea leveraging their competitive advantage of low-cost labor to eventually become high value-added designers (think Samsung and Sony). Further, Porter wrote about the importance of industry clusters in spurring innovation.

What can Saudi Arabia offer? Do they think they can build a Silicon Valley or a biotech or healthcare behemoth in the desert? What are the competitive advantages and industry clusters that they can build on?

Sure, I can understand tourism as a growth driver, as Mecca is a magnet of steady visitors on the Hajj. Beyond pilgrims, however, Saudi Arabia doesn’t sound like a natural spot for tourism.

The idea of state spending to jump-start these initiatives are likely to fail. I am not necessarily saying that government shouldn’t use fiscal policy to spur growth, but the underlying approach is wrong. As an example, the US government has put military bases in fairly remote spots to boost employment and appease the local Congressional representative, but few of those efforts has built long lasting employment beyond services dependent on the base. On the other hand, selective efforts such as the combination of academic-private partnerships and initiatives like the DARPA challenge has yielded innovation.

There is a right way and wrong way to design industrial policy. Saudi Arabia is going about it the wrong way. A more sensible way is to encourage industries where KSA has a natural competitive advantage and build on it. Tourism is one. Others might include the encouragement of an industry cluster in energy services, either in the form of oil extraction engineering services or refining and processing.

Remember Chinese rebalancing?

What KSA is attempting is a form of economic rebalancing through industrial policy, which is a very tough road to take.Consider China, which has largely gotten the direction of policy right in their strategy of rebalancing growth away from credit-driven infrastructure growth to a more sustainable consumer-led growth model.

As my chart of New (consumer) China vs. Old (financial) China pairs show, rebalancing is continuing. Given the kind of market angst that surround the outlook for Chinese growth right now, this road isn`t exactly a smooth one.



I can only conclude that the Saudi economic diversification initiative is likely to fail. If KSA persists in its policy of maintaining low oil prices and believe that diversification will cushion the blow, it risks a collapse of its fiscal house and perhaps a political collapse of the House of Saud as well.

9 thoughts on “Why the Saudis will either blink…or collapse

  1. The train is barreling down the tracks, the KSA car is dead on the tracks, and they’ve just announced to the people in the back seat that they are replacing the engine. Don’t worry, we can totally get it replaced before that big light hits us.

  2. Just like to give kudos to Cam Hui. I have marveled at how great pianists can play one side of a score with their right hand and a seemingly different one with their left, to make an intricate, beautiful sounding overall performance. Cam’s ability to play the short and intermediate terms with sound and differing reasoning is just as hard and well done.

  3. Saudi nationals prefer to work in the public sectors where they get paid more, have job security and can work as little as they please. Those in the private sector are looked down upon and thus are filled with foreign workers. Developing a thriving private sector is going to be challenging.

  4. Ventures into private enterprise usually fail. This shouldn’t be a surprise considering the number of new businesses that fail within the first six months of operation. Restaurants and tech startups fail all the time, usually around 80%+ of of those types of businesses fail within the first 2 years.

  5. I know nothing about KSA on the ground but I wouldn’t sell the Saudis short just yet. If cheap oil persists beyond two quarters it will be a tremendous boon to the global economy. The Saudis could get in on the ground floor of the boom they created. They should look for a domestic use for their oil. I don’t know what kind of aluminosilicats they are sitting on but tankers can be filled with portland. The hot new cement is metakolin. A potentially tremendous market. Just one idea.

    I’m sure they can find a non-oil related nitch in the global market.

  6. What KSA has been unto has been really comical. Alternative energy is making some inroads, and there is growing supply from the US, Iraq and Iran. Russia is always willing and able to sell oil. Trying to play a price war would not have been the first thought in my mind. I would have tried to leverage 100$ oil to the maximum, but they did the opposite. Yes, the Shale producers could go belly up, but as (and when) the price of oil goes higher, there will be increased drilling, ensuring competition to Saudi Crude. As regards trying to diversify KSA’s income/revenue sources, good luck. The population is ill educated, dependent on hand outs and not exactly sought after in the global race of skills. There is no manufacturing, agriculture nor value addition in the KSA. Yes, I am sure there are petrochemical plants in Saudi, but that industry can find competitive feedstock in the US and Canada. As regards tourism, good luck.

  7. The House of Saud can not buy its way to sustainable economic transformation. Tourism is not the answer. The knowledge they already possess is the key to their salvation, if they would only look inward and discover how to use it.

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