Oil Price Drop Highlights Need for Diversity in Gulf Economies

SUMMARY

Countries of the Gulf Cooperation Council will have to adjust the incentives of workers and firms to encourage them to work and produce in the non-oil tradable sector if these economies are to succeed in diversifying their economies, a new IMF study says.

 
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  • Decline in oil prices highlights need to diversify Gulf economies
  • Oil revenues distort incentives for region’s firms and workers
  • New export markets, better education, fewer government jobs will be key
  • With oil prices declining by 40 percent since June, the importance of diversification is once again highlighted.

    While governments in the region have made some progress toward economic diversification in recent years, much remains to be done. The strategies pursued thus far have yielded mixed results, according to the report.

    To make significant progress toward reducing their reliance on oil, GCC governments need to change the incentive structure of the economy to encourage individuals to work in the private sector and induce firms to look beyond domestic markets for new export opportunities, the authors say.

    New growth model needed

    The GCC growth model—which relies on oil as the main source of export and fiscal revenues—has delivered strong economic and social outcomes. Over the years, GCC governments have increased public sector employment and spending on infrastructure, health, and education. This has helped raise standards of living and support private sector activity, particularly in such sectors as construction, trade and retail, transport, and restaurants.

    But the current growth model has weakness, the report points out. Greater diversification would reduce exposure to volatility in the global oil market, help create private sector jobs, and establish the non-oil economy that will be needed in the future when the oil revenues dry up.

    Why have the diversification policies pursued to date by GCC governments fallen short of their goal? The paper examines the experience of other oil-exporting countries and draws possible lessons for the GCC.

    Case studies in success

    Historical experience offers few examples of countries that have been able to successfully diversify away from oil, particularly when their oil production horizon is still long. A number of obstacles often stand in the way of diversification, such as the economic volatility that is induced by the reliance on oil revenues or the corroding effect that oil revenues have on governance and institutions. Economies rich in oil also often see a decline in competitiveness of other economic sectors caused by the appreciation of the real exchange rate as resource revenues enter an economy, a phenomenon known as Dutch disease.

    Success or failure appears to depend on the implementation...

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