Michael Herb, Georgia State University

This chapter is part of POMEPS Studies 33: The Politics of Rentier States in the Gulf. Download the full PDF here.

Introduction

The Gulf monarchies must eventually diversify their economies: they must sell something to the world other than oil (Cherif and Hasanov 2016; Staff of the IMF 2016; Callen et al. 2014). For some Gulf economies – Oman, for example – the need to diversify is pressing. Others, such as Kuwait, can sustain their citizen populations on oil revenues for a while longer, but still need to consider how to structure their economies in preparation for the day when oil export revenues will not sustain the current standard of living.

It is not easy to diversify any economy dependent on the export of a single primary resource. In the Gulf, such diversification is made even more difficult by the structure of the labor markets. Each of the Gulf monarchies has two labor markets, one for citizens and the other for foreigners. In the richer rentiers these two labor markets are almost entirely separate. Citizens mostly work in the public sector and foreigners in the private sector. In the public sector, citizen employment is a method of distributing oil revenues. Thus the relatively high wages paid to most Gulf citizens — especially in the richer rentiers — have little relationship to labor productivity and have little relationship to market wages for foreign labor. Private sector employers typically hire citizens only when obliged to by government policy and even then often do not make much effort to put citizen labor to productive use.

Labor costs in the private sector are therefore low due to the presence of millions of foreign workers whose reservation wage rates are set by their home economies. This shapes the nature of the potentially competitive sectors available to investors in the Gulf economies. Successful economic diversification in the Gulf today has taken place primarily in the UAE, where diversification is highly reliant on foreign labor. No Gulf monarchy has successfully diversified any substantial part of its economy by employing citizen labor. The central question of Gulf diversification, then, is whether it will be citizens or foreigners who provide the labor in the diversified sectors of the economy.

Diversification with whose labor?

There are roughly four options for labor in diversification in the Gulf. Each carries potential risks as well as benefits, and each touches on core elements of political economy and ruling structures.  These options are the result of two choices. First, how heavily do the Gulf states want to rely on foreign labor in their economies? Second, to what degree do they want to create a separate labor market for citizens with a higher wage rate, less onerous working conditions, and so forth?

1. Embrace foreign labor

One approach, found most prominently in Dubai, is to fully embrace the use of low-cost foreign labor to build a diversified economy. This favors economic sectors like tourism that require large amounts of low-cost labor. This economy is then taxed, producing revenue that can be distributed to citizens via public sector jobs (though citizens today primarily rely on the state’s oil income). The Dubai strategy requires plentiful foreign labor: in the UAE today the ratio of non-citizens to citizens is in the neighborhood of eight to one.

While there is some high-wage foreign labor in Dubai, the bulk of the diversified economy is low-wage, especially in the hospitality and logistics industries. This makes it hard to transition to a high-wage economy that relies on expensive citizen labor. The more likely result is that Dubai continues to tax the diversified economy and uses the proceeds to fund government services and to pay the salaries of the citizens who provide those services. In the long term the strategy has an immense political cost: it makes citizens a small but very privileged minority in their own country, living on the tax revenues generated by millions of resident non-citizens.

Perhaps the most serious problem with the model, however, is that it is not easily achievable outside the richest and smallest of the Gulf rentiers. The model works best in countries with a high per capita oil income (as is the case in the UAE as a whole) and a relatively small number of citizens. Saudi Arabia has too many citizens, as does Oman. Kuwait has not created a business environment attractive enough to seriously imitate Dubai. But despite the impracticality of the Dubai model, a survey of Gulf labor markets until very recently would suggest that is exactly the model all six Gulf monarchies wish to follow.

2. Merge the labor markets

A second strategy is to embrace a low-cost labor strategy but combine the citizen and non-citizen labor markets into one without reducing the role of foreign labor in the economy. Diversification could then proceed with low-cost citizen and foreign labor. International financial institutions favor this strategy. It would be carried out by reducing the number of citizens employed in the public sector and cutting the wages of those who remain (International Monetary Fund 2015, 19).

If cheap foreign labor remains abundant, this strategy impoverishes less-skilled citizens. Some citizens would adapt to the decline in their circumstances and join the labor market alongside foreign labor from poor countries, but many would remain at home, unemployed, reflecting on how they are not receiving their fair share of their country’s oil wealth. None of this is politically palatable. Education is not the solution, except at the margins: there needs to be a place in the labor market for less well educated Gulf citizens.

Budget pressures, in the end, may require some of the Gulf monarchies to limit employment by citizens in the state sector and to cut salaries. But overall this strategy, executed in a determined way, is likely to be a very last option. In countries that still enjoy substantial oil wealth, reducing the standard of living of unskilled citizen workers to that of laborers from some of the world’s poorest countries is simply not a politically sustainable option.

3. Rely on citizen labor only

A third strategy is to radically reduce the amount of non-citizen labor in the Gulf countries. This would close the door to a low-cost labor diversification strategy and force the Gulf economies to diversify, if and when they do, with citizen labor.

The Gulf monarchies are very unlikely to embrace this strategy completely (though some public discourse in Kuwait suggests some support for the strategy there). Nonetheless it is worthwhile, as a thought experiment, to consider the consequences of radically less foreign labor in the Gulf as a way of illustrating the complex interactions between labor markets, diversification, budgets, and political constraints. Economic activity would decline sharply, with the most serious impacts falling on owners of real estate and businesses that employ mostly foreign labor. Wage rates would rise sharply and the cost of locally produced services would also rise. Because the state does not tax the economy much the decline in economic activity would not harm state revenues, and a decline in the number of residents would reduce state expenses on infrastructure, health care, policing, energy subsidies, and the like. Put differently, the fixed amount of available hydrocarbon resources would last longer. Funds that would have been sent abroad as remittances would stay in the local economy. Countries that rely on remittances from the oil-rich Gulf states would lose these remittances, and overall would be the most seriously harmed from a result of more restrictive labor policies in the Gulf monarchies.

Finally, businesses that seek to produce tradeable goods would face higher labor costs but would also have available a citizen labor force accustomed to working in the private sector. In the long run, the goal would be to develop a citizen labor force that works productively in the private sector producing non-tradeable goods for other citizens. Citizen labor that is productive in the private sector might also develop the skills necessary to produce non-energy exports as well.

4. Limit the role of foreign labor

The fourth strategy is the one most likely to be pursued by the Gulf regimes (apart from the UAE and maybe Qatar). Instead of relying only on citizen labor, the regimes segment the private sector labor market, reserving some areas (usually sectors, or professions) for high-cost citizen labor, and other sectors for low-cost foreign labor. This achieves some of the positive aspects of the third strategy while avoiding the most intense negative effects. Less foreign labor raises the cost of labor overall, lowering state expenses. Citizens, however, retain some of the cost advantages of having non-tradeable services provided by low-cost foreign labor.

The strategy requires a very strong administrative apparatus that rigidly maintains the boundaries between sectors reserved for citizens and those open to expatriates. In the absence of strong institutions, politically connected businesses will circumvent the rules and hire foreign labor wherever and whenever possible. The Gulf states, however, have a poor record of imposing labor market regulations on powerful private interests.

Recent changes?

The key measure of the success of these choices of strategy is the ratio of citizens to foreigners in the labor force, and in particular in the private sector. Until very recently, all the evidence pointed toward movement toward, if anything, the Dubai model: the number of expatriates in the workforce in Gulf countries rose across the board. This was true of the UAE and Qatar, but also of less-wealthy Oman, Bahrain, and Saudi Arabia. Figure 1 gives a sense of the changes between 2009 and 2015 in Saudi Arabia: employment grew for expatriates in the private sector and citizens in the public sector. This was despite the many and widespread government announcements of labor market reforms that would lead to increased citizen participation in the private sector.

In the past year or so, however, we have seen some signs of actual change in labor market figures reported by some of the Gulf rentiers. The Saudi government released figures for the first quarter of 2018 that showed a decrease in the number of foreigners in the labor market of 700,000 over the previous five quarters, to 10.2 million (Bloomberg 2018). This was in part a result of the imposition of a $26 monthly fee on the dependents of expatriates, along with the announcement of the reservation of most retail jobs for Saudi citizens. Yet it is also the case that these sorts of labor market regulations have been announced in various Gulf states in the past and have been accompanied by ever greater reliance of the private sector on ever greater amounts of foreign labor. The crucial measure of the effectiveness of these regulations is their impact on demography. An actual decline in the number of foreign workers is significant, especially as comes during a period of a recovery in the price of oil.

In Oman, where the non-citizen percent of the population rose from 29 percent to 45 percent from 2007 to 2017, the number of non-citizens in the country dropped by two percent from May 2017 to March 2018 (The Times of Oman 2018). This is not enough of a drop to suggest a permanent change, though there are indications that it is more than just a statistical blip. Across much of the Gulf the real estate market has declined recently, and the industry blames this on the departure of foreign labor. In Kuwait one industry source cited a fall in residential rents of 13 percent in a report for 2017 (Gulf News 2018). In Oman the departure of skilled labor has been blamed for a real estate crisis that has left numerous building owners facing bankruptcy, according to a of Bank of Oman official (al-Shaibany 2018). That said, the real estate market is also weak in Dubai, where the population increased over the past year from 2.9 million residents to 3.13 million, so fewer non-citizens is not the explanation there (Government of Dubai. Dubai Statistics Center n.d.). Nonetheless the fact that the real estate industry blames price declines on labor force policies does illustrate who has something to lose in the Gulf governments, successfully limiting the number of foreign residents.

Conclusion

It may be that, after decades of talking about demographic reform, the Gulf states have actually become serious about it. The consequences of this for expatriates and their home countries are not good: remittances will fall, and job opportunities will be more limited. In the worst cases, undocumented immigrant families have been broken apart in immigration raids. The most severe consequences are visited on those with the fewest resources.

The implications for the future diversification of the Gulf economies, however, are more positive. In the long term the only permanent solution to lower oil prices is the production of non-hydrocarbon tradable goods and services in the Gulf economies. This can be done with citizen labor, or without. The Gulf economies need to either adopt the Dubai model, with its political risks, or find ways to put citizen labor to work in productive ways in both the non-tradable and tradable sectors. Recent changes suggest, for the first time, that some Gulf states may choose to rely on citizen labor in the further development of their economies.

 

Bloomberg. 2018. “Expatriate Workers Are Leaving Saudi Arabia in Droves.” Bloomberg.Com. July 9, 2018. https://www.bloomberg.com/news/articles/2018-07-09/expatriate-workers-are-leaving-saudi-arabia-in-droves.

Callen, Tim, Reda Cherif, Fuad Hasanov, Amgad Hegazy, and Padamja Khandelwal. 2014. “Economic Diversification in the GCC: Past, Present, and Future.” SDN/14/12. IMF Staff Discussion Note. http://www.imf.org/external/pubs/cat/longres.aspx?sk=42531.0.

Cherif, Reda, and Fuad Hasanov. 2016. “Soaring of the Gulf Falcons: Diversification in the GCC Oil Exporters in Seven Propositions.” In Breaking the Oil Spell: Gulf Falcon’s Path to Diversification. Washington, DC: International Monetary Fund.

Government of Dubai. Dubai Statistics Center. n.d. “Population Clock.” Accessed November 21, 2018. https://www.dsc.gov.ae/en-us/EServices/Pages/Population-Clock.aspx.

Gulf News. 2018. “Kuwait Faces Real Estate Crisis as Expats Leave.” May 7, 2018. https://gulfnews.com/world/gulf/kuwait/kuwait-faces-real-estate-crisis-as-expats-leave-1.2217502.

Herb, Michael. 2017. “The Political Realities of Economic Reform in the Gulf Monarchies.” 25. ERF Policy Brief. Economic Research Forum. http://erf.org.eg/publications/the-political-realities-of-economic-reform-in-the-gulf-monarchies/.

International Monetary Fund. 2015. “Saudi Arabia : 2015 Article IV Consultation – Press Release; Staff Report; and Informational Annex.” 15/251. Country Report. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Saudi-Arabia-2015-Article-IV-Consultation-Press-Release-Staff-Report-and-Informational-Annexl-43261.

Shaibany, Saleh al-. 2018. “Oman Faces Property Crash as Foreign Workers Leave.” The National (Abu Dhabi). May 12, 2018. https://www.thenational.ae/world/gcc/oman-faces-property-crash-as-foreign-workers-leave-1.729587.

Staff of the IMF. 2016. “Economic Diversification in Oil-Exporting Arab Countries.” http://www.imf.org/external/pp/longres.aspx?id=5038.

The Times of Oman. 2018. “After a Decade of Growth, Number of Expat Workers in Oman Declines.” March 10, 2018. http://timesofoman.com/article/129766.

Labor markets and economic diversification in the Gulf Rentiers