Getting There

Author:Rabah Arezki

Getting There Finance & Development, December 2017, Vol. 54, No. 4

Rabah Arezki

Oil-producing countries must focus on how to diversify their economies

Many oil- and gas-rich countries—including those in the Middle East and North Africa, such as Algeria and Saudi Arabia—have either announced or put in place policies to reduce their dependence on oil by diversifying their economies. The collapse in oil prices—which started in 2014 (see chart) and is expected to be protracted—has put diversification at the forefront of the policy debate. 

Although many fossil fuel exporters understand the need to diversify, few have successfully done so. Historically, diversification away from oil extraction has been difficult for such oil-rich nations—in large part because the top-down approach of the state has not given managers and other economic agents the confidence or incentive to embrace new ideas, innovate, and take risks. For example, the incentive structures of state-owned oil companies in many countries around the world, including in the Middle East and North Africa, have not consistently encouraged managers and employees to achieve their full potential and adapt to new technology rapidly affecting their industry. Many state-owned companies embark on missions outside their core activities and competencies, innovate little, and struggle to keep talented employees. What’s worse, several state-owned oil companies around the world have a heavy burden of debt, even though they sit on large oil reserves that are relatively cheap to extract. 

Shift in focusBut if countries were to shift their focus from the end goal, diversification, to how to get there—that is, to the transformation process—they might find it easier to diversify. The effort involves steps to shift away from the dominant oil and gas sector. A focus on transformation involves an approach to that dominant sector that can spill over to, and even help foster, sectors outside hydrocarbons. That is, by embracing transformation, countries will focus on getting incentives right for managers and other economic agents and turn into friends the technology and innovation energy markets now see as disruptive enemies. Countries that take this approach are less likely to stumble or resist change. 

Technological changes in energy markets can help the sustainability of economies that depend on oil revenues. More agile economic systems with appropriate corporate governance structures—that empower managers and employees—can more easily take advantage of new...

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