(Originally published on January 31, 2017, as part of LSE’s Political Risk and Investment Society Spotlight Blog)
Following two years of rapidly declining oil prices, Saudi Arabia has realized that it needs massive reform for its economy to stay relevant and its country stable in the coming years. Low prices, sparked in part by OPEC’s (read: Saudi Arabia’s) decision to allow market forces to determine the price of oil, created a hole in the Saudi budget, forcing it to draw on $100 billion of reserves and borrow another $17.5 billion in bonds. The Saudis now realize that oil can no longer be the basis of a growing economy. In response, Deputy Crown Prince Mohamed bin Salman (MbS) has been given control over the state’s oil monopoly, national investment fund, economic affairs, and Ministry of Defense – a move designed to centralize the coming reform process.
Overall, the reforms are designed to diversify the economy away from a reliance on oil, keep and attract capital for domestic investment, and foster accountability and transparency in the government bureaucracy. A major plank of the reforms is a five percent initial public offering of Saudi Aramco, the state-owned oil company and the largest oil company in the world. The sale is expected to raise $2 trillion, which will be used to fund the reform project. Yet the sale itself will require major reforms in transparency. The Royal Family and other government officials will no longer be able to use the company as a private bank, as earnings and costs will now be subject to investor scrutiny. Since it is a state-owned company, transparency reforms will need to ripple throughout the government, which MbS is hoping will improve accountability.
Other reforms include privatising the health sector and airports, building a domestic arms industry, and ramping up the renewable energy sector. The government plans to invest $30-$50 billion in renewable fuel, largely for domestic use, in an attempt to free more oil for export. Moreover, the Public Investment Fund, Saudi Arabia’s sovereign wealth fund, is investing abroad, a new move from its traditionally inactive role. It recently acquired a $3.5 billion stake in Uber, and is joining with Japan’s SoftBank to create a new $100 billion technology fund. The Fund is also hiring young, Western educated professionals. In a country where over half the population is under 30, creating a growing economy with high paying jobs is a top concern.
Saudi Arabia needs diversification. Attracting foreign capital to build new financial sectors, privatising bulky state-run systems, and creating new sources of energy are likely to benefit benefit the Saudi economy, state, and population. Whether or not these reforms will really achieve the change needed, however, is another question. Hiring costs are a big problem: it currently costs four times as much to hire a Saudi as it does a foreign worker. Women are another: they are artificially kept out of the workplace, and so only make up 23% of the workforce. The plan calls on increasing that number, but creating jobs that address both the cost and can absorb increased female participation will be challenging. On the religious front, the Saudi state has a long history of abandoning reforms that the country’s fundamentalist clerics oppose. While the state has started to push back in recent years, greater numbers of women working and a freer flow of Western culture may unite the clerics in opposition to the reforms.
Internationally, the reforms are far too late. Saudi Arabia lags behind its Gulf neighbors in diversifying its economy and has largely maintained its economic clout by the sheer size of its oil wealth. Both Qatar and the United Arab Emirates have proven the success of economic diversity, becoming global finance and tourist hubs in their own right. Saudi economic diversity also falls behind that of Iran. With money beginning to flow back into the Islamic Republic, Saudi Arabia needs the reforms to work just to keep up.
If the reforms succeed, they will secure Saudi Arabia’s position in the center of Middle Eastern economic life, allowing the kingdom to maintain and expand its regional influence in a tumultuous region. Yet they face many challenges, and if the reforms fail, Saudi Arabia will be left behind as the region and the world moves away from oil dependence.