Global Market Commentary

Saudi Arabia’s Bid for Transformation: Can It Work?

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Saudi Arabia’s Bid for Transformation:  Can It Work?

Saudi Arabia has troubles.  Our regular readers have heard us discuss them often, especially in the wake of the dramatic decline in the price of oil between mid-2014 and the beginning of 2016.

Countries whose economy relies predominantly on oil and other hydrocarbons are often said to suffer from “the resource curse” — a tendency for that reliance to stunt the development of other productive sectors of the economy.  This leads to an economy which is highly vulnerable to price shocks in the commodity on which it depends.  It also tends to produce a political order troubled by cronyism and the habit of smoothing over social conflicts and economic underdevelopment with lavish government spending on social programs.  It all works when commodity prices support it.  When they fail, though, the results can be spectacularly disastrous.  Every country where it happens has its own unique characteristics; the world is currently seeing one tragic example as Venezuela’s “Bolivarian Revolution” unravels amidst riots, repression, and hunger.

Oil Riches Drove the Saudi Boom

Between January, 1999 and June, 2016, the price of oil increased more than eight-fold, with considerable volatility.  At its pre-financial crisis peak in 2008, it was more than eleven-fold higher than in December of 1998.

Saudi Arabia at the beginning of this period was still the world’s decisive swing oil producer.  It rode the boom as resource economies often do, and better than many.  In the decade between 2003 and 2013, it became the world’s 19th-largest economy.  GDP doubled.  Household income rose 75 percent in real, inflation-adjusted terms.  The government spent heavily on health, education, and infrastructure.  It had built up reserves equal to nearly 100 percent of GDP by 2014.

Then the crash came, the tide went out, and the naked swimmers were revealed.  The Saudi government had helped incubate an entitled, ill-educated population with its largesse.  Productivity growth had been anemic.  Non-energy sectors of the economy were weak or non-existent.  A bulge of young people approaching prime workforce age had small prospects of employment in the underdeveloped private sector, and were expecting low-work government sector jobs with high pay and benefits.  Almost all the really productive workers in the Kingdom were low-paid foreigners.  The government began burning through its reserves at a rate that alarmed global financial organizations and analysts.  Looking down the road, both Saudis and foreign observers began to see increasing instability as the likely outcome if no corrective action was taken.  Various technological challenges, from shale oil to rapid electric vehicle innovation and uptake, may presage a lower oil price for longer than suspected (indeed, perhaps forever, if the “peak oil demand” forecasters are correct).

Vision 2030

Enter Saudi’s new deputy crown prince, Muhammad bin Salman (“MbS” for short), the second-in-line to succeed the aged and ailing King Salman.  At 31, MbS is a savvy young face for the ruling family.  His energetic rise to prominence began in earnest with the death of the previous monarch, King Abdullah, in 2015.

On April 26, 2016, MbS promulgated a sweeping strategic vision for the Kingdom’s economic development, called Vision 2030.  It was largely constructed on the basis of consulting done by Western firms such as McKinsey.  Vision 2030 put forward a program of economic and fiscal reforms that would raise private-sector pay from 19 percent of total household income to 58 percent.  Many industries would be liberalized to serve as engines of growth, including mining, petrochemicals, manufacturing (concentrating especially on the defense sector), retail, construction, tourism, health care, and especially finance.  The vision is one that sees Saudi parlaying its geographical position into a role as a hub for commerce and finance, and envisions the country selling off a stake of the national oil company to create the world’s largest sovereign wealth fund — with much of it to be invested in education and physical infrastructure for the Kingdom.

Trump’s Signature Handshake With the Architect of Saudi Transformation

Source:  Al Arabiya

The goals were grand and sweeping.  However, the McKinsey report that largely informed Vision 2030 commented:

“For our analysis and conclusions, we have focused purely on economic factors.  While we are conscious that the security and politics of the region could affect the potential transition we outline here, we have not taken them into account for the purposes of this report.”

While it is an analytical strength to concentrate on a limited range of phenomena, the sole concentration of Vision 2030 on economics is, we believe, a notable lapse, and one that suggests to us that we should dig a little deeper to see the challenges that call the bold plan into question.

One Year In, How’s Vision 2030 Proceeding?

Vision 2030 just passed its first anniversary with a disappointing event.  Back in September, the government announced a 20 percent cut in the pay of many government employees, and the curtailing of benefits.  It was the kind of austere behavior that global observers were looking for.  However, it was not well received by the Saudi populace — and in late April, King Salman announced that the cuts would be rolled back.  MbS suavely painted the rollback as planned, saying that the economic situation had improved, so why would austerity measures be necessary?

The bottom line is that the deeper political and cultural context will make Vision 2030 very difficult to realize.  In essence, that context is this: the tacit contract that has long existed between the Saudi ruling family and the people of the Kingdom is one where obedience to the regime is rewarded with the state’s largesse.  And there are many simmering tensions within the Kingdom that have been damped by ample distribution of oil wealth, not least the resentments of the Kingdom’s minority Shi’ites, who happen to live in the peninsula’s most oil-rich areas.  Apart from Shi’ites, much of the Kingdom’s populace is deeply conservative.  Many ordinary Saudis resent the royal family for their lavish lifestyle, and for what they view as hypocritical public lip-service to Islamic ideals while their private lives are much more amenable to Western libertinism.  The Kingdom’s particularly austere form of Islam, Wahhabism, has been linked to extremism around the world — and while the Kingdom’s rulers have not been shy in using Wahhabi proxies to pursue regional and global ambitions, the same forces do not really wish them well at home.

This underlies the most significant reason to suspect that Vision 2030 will not develop in the linear fashion that MbS’ founding program imagines.  If it conjures any precedent, it’s the ill-fated modernization drive initiated by the Shah of Iran in 1974 — a program which in its single-minded determination to push breakneck Westernization and economic growth, may have helped spark the 1979 Iranian Revolution that brought the current theocracy to power.  

On paper, the solution may be a good one.  On the streets, we are not so sure.  There is also the dimension of palace and regional politics; Saudi Arabia’s recent orchestration of a diplomatic blockade against Qatar suggests that Saudi’s rulers are feeling more comfortable with American support, and intend to flex their muscles as regional hegemons.  MbS has come under criticism for being cavalier and aggressive in his foreign policy ambitions.

MbS himself is certainly trying to paint himself as “the people’s prince,” and attempting to polish his credentials with Saudi’s struggling middle class, in time to secure his standing with the next King when the time comes.  Certainly, it’s the Kingdom’s wealthy who stand to suffer the most if the plan moves ahead as described — and the Kingdom’s less well-off citizens know it.

The bottom line: Vision 2030 will be unlikely to play out in the form it’s been presented.  There are many political dynamics within the Kingdom, within the Saudi ruling family, and among the region’s powers.  These shed more light on the ills Vision 2030 is trying to address, and on what else is going on beneath the surface besides a pure call for economic growth, diversification, and liberalization.

Investment implications:  We would be cautious to participate as the liberalization of the Saudi economy proceeds — for example, when Saudi Aramco shares are offered to the global investing public.  As always, we will keep a close eye on the Kingdom’s internal politics and external regional relationships.  We are not suggesting that trouble is imminent — but Vision 2030 is not enough to convince us that the Kingdom is dealing with its deeper troubles in a way that will ultimately succeed.

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