Yousef H. Al-Ebraheem is dean of the College of Administrative Sciences and associate professor of economics at Kuwait University. In August 1993-September 1995, he served in the cultural division of the Kuwaiti embassy in Washington, D.C.
The economies of the six Gulf Cooperation Council (GCC) countries rank among the most sound of all developing states. For example, Moody's investor services gives Kuwait, the United Arab Emirates (UAE), Oman, Saudi Arabia, Bahrain, and Qatar a sound investment grade.1 Similarly, the Bank of America's "Country Risk Monitor" report for 1995 ranks the UAE and Kuwait in the top ten, while Saudi Arabia and Bahrain also rate well.
Notwithstanding such glowing evaluations, deep undercurrents of change are underway in these economies. In particular, they suffer from a decline in real per capita income and a growth in the public deficit. These developments imply not just new problems but potential questions about regime survival. We shall look at the major development constraints in the GCC states and then focus on Kuwait as a case study.
The major jumps in the price of oil during 1973-74 and 1979 gave GCC countries a historic opportunity to achieve sustainable economic development with diversified high-value-added economic sectors. Their oil revenues jumped from $8 billion in 1972 to $150 billion in 1980. Meanwhile, their gross domestic products (GDPs) increased from $14 billion in 1972 to $67 billion in 1975 and peaked at $242 billion in 1982. Per capita income increased proportionately, from $1,300 in 1972 to $16,500 in 1980.
These huge financial resources, unfortunately, were squandered. Indeed, the economies of the GCC states face today roughly the same challenges as they did thirty years ago, before the oil wealth, only now the problems are maybe greater. Taking into account differences in size, magnitude, and the tools to deal with these problems, each of the countries faces six similar challenges.
Wealth. The GCC economies still possess vast amounts of mineral resources, including 46 percent of the world's oil reserves (465 billion barrels) and 15 percent of its natural gas reserves (720,000 billion cubic feet). Because of the low cost of extraction, these countries control about 80 percent of the world's excess oil- and gas-production capacity.
Government revenues. In real terms, oil revenues have declined sharply during the past decade. Adjusted for inflation, the price of a barrel of oil in dollars is now below its level in 1974. TB: I have a graph from the NYT somewhere showing this DP Furthermore, the exchange-rate value of the dollar against major currencies has declined by 50 percent since 1980. Despite this precipitous decline, oil remains the dominant source of GCC government revenues for the simple reason that the governments have not succeeded in generating other sources of revenues.
Population. The population size in the GCC has more than doubled in twenty years, increasing from about 10 million persons in 1975 to about 25 million in 1995. Of this number, 30-80 percent of the population are expatriates (Oman and Saudi Arabia are at the low end, UAE at the high). The growing number of residents increases the government expenditures needed just to maintain the existing benefits of medical care, education, jobs, and a host of subsidies. The continued reliance on expatriate labor also has other, non-economic implications, leading to a variety of social and (potential) political problems.
Budget deficit. Budget deficits are the paramount issue on the economic docket throughout the GCC. True, the budget deficit began in the mid-1980s, a result of much lower oil revenues (from $150 billion in 1980 to $25 billion in 1986), but at that time these countries could offset the decline in oil revenues by tapping their enormous financial reserves, which by then had reached over $300 billion. Those reserves are now much reduced, making the deficit far more of a problem. The budget deficit now affects the balance of payments, the rate of inflation, economic growth, the overall welfare system, and the very social fabric of the GCC societies.
Military spending. The military is a permanent and major component of government expenditures. Prior to the Iraqi invasion of Kuwait, GCC countries in the aggregate ranked in the top twelve countries in terms of military spending. According to the International Monetary Fund, the GCC spent 13 percent of its GDP on arms, compared with the whole of the Middle East, which spent an already very high 5 percent of GDP.2 Just reducing their military spending to the average Middle Eastern level would have saved the GCC countries around $30 billion a year before 1990.3 Published government documents show that the GCC devoted on average a third of its total financial resources on security-related purposes.4
Military spending has only increased since the Kuwait war, so that it is now about 20 percent higher than the pre-1990 level. The total amount is estimated to be more than $50 billion ($5 billion in arms purchases from the United States in 1994 alone). The actual numbers may be higher because all the GCC budgets except for Kuwait's lack transparency and accountability; some major spending items are either not included or buried under an "unspecified expenditure and transfers" rubric. Military spending has crowded out expenditures on other important matters, such as health care, education, and infrastructure. Moreover, military spending generally causes subsidies to be reduced and taxes increased, thereby leading to an increase in income inequality.
Job opportunities and economic activity. Mix a very high rate of population growth (3.5 percent per annum) with a failed educational system and you have a profound imbalance between economic demands and the competence of the labor corps. To exacerbate matters further, most citizens work for the government, not in business. This situation has led to a great influx of foreign labor, to the point that it now constitutes on average 80 percent of total labor force.5
To absorb the growing population, GCC economies need to create 200,000 jobs per year. The real decline in oil revenues means that governments cannot continue providing jobs for their nationals. But private enterprise is not able, at present, to create all these job opportunities. The GCC is heading to a situation of increasing unemployment, with all the attendant social and political maladies. Bahrain, with a 20 percent unemployment rate, appears to be leading the way; indded, its high rate of unemployment is a major factor contributing to the violence and social unrest experienced in that country since late 1994.
Expanding oil production requires new investments and modern technology. Several studies estimate the cost of expansion to be in the range of $32-$100 billion over the coming ten to fifteen years. (Table 1 depicts some of these estimates). Lacking funds and know-how, GCC states have no choice but to invite foreign capital and international oil companies to participate in these expansion projects. Indeed, some companies are already participating in downstream projects in the region. This trend represents the beginning of a new era of de-nationalization.
AT THE CROSSROADS
The GCC states now stand at a major crossroads. They face increasing demand for funds to maintain the existing welfare system and other expenditures; but their wealth is still concentrated in a single asset, oil, and they face serious constraints in transforming this asset into a stable and continuous stream of income. New political and economic realities -- relations between the West and the Middle East after the Kuwait war, the growing oil supply outside the Organization of Petroleum Exporting Countries (OPEC), and the financial problems facing OPEC states -- do nothing to reduce this quandary.
Continuing to spend as of old might lead to problems more serious than merely the financial and economic. The erosion of real income for the majority of the population in the middle class, the declining welfare system, a lack of job opportunities for the youth who make up more than 45 percent of the total population: these issues could pave the way for very serious social and political tensions of a sort previously unheard of.
In an attempt to change this course, the GCC governments have announced economic reform programs to reduce budget deficits, minimize the volatility of oil revenues, foster the role of private enterprise, and control the inflow of foreign labor. While necessary, such economic reforms are not sufficient to change the current course; political reforms are needed as well. Governments must broaden popular participation and increase popular involvement in the decision-making process. They must also introduce accountability and transparency to government accounts and finance. These political reforms would permit GCC states to adopt unpopular austerity programs, the sort that will change the course of their economies without fomenting radical resentment.6
KUWAIT'S BUDGET CRISIS
Kuwait stands out as the GCC country with the most detailed and reliable data, and so permits a particularly close analysis of trends.
Kuwait's budget deficit began in fiscal year 1981-82, a result of two factors: a 48 percent decline in oil prices and an 18 percent increase in government expenditures (in current prices) during the period 1979-80 to 1989-90. The size of the deficit correlated closely with the decline in oil prices: in 1986-87, the oil prices fell below $10 per barrel, which led to a KD (Kuwaiti dinar) 1.3 billion ($4.3 billion) deficit that year. The cumulative budget deficit during the 1980s came to KD 6.2 billion, or $20 billion.
Large as this number is, it did not portend serious problems. In fact, the numbers were better than they looked. For example, the government had foreign reserves worth $80-100 billion but its accounting system excluded the income from these reserves, which at one time matched the income from oil sales, from its figures. For several years, the deficit was financed using precisely those foreign reserves earnings. Then, in 1987, it was financed by issuing treasury bills and bonds. The ceiling of these public-debt issues began with KD 1.4 billion, then was increased to KD 3 billion in 1989.
The Iraqi invasion had a massive impact on Kuwait's financial position, depleting much of the country's foreign reserves while creating a large budget deficit and public debt. The government also adopted popular, but not sound, economic policies, further reducing financial reserves while increasing the deficit.
To liberate and rebuild Kuwait after the Iraqi invasion, the authorities exhausted a large portion of their foreign assets. The seven months of the Iraqi occupation and expulsion cost KD 14.7 billion ($49 billion); this amount reached KD 20 billion ($66.7 billion) by the end of the fiscal year 1994-95. A quarter of this amount represents the cost of debt forgiveness. such spending left Kuwait with just 40 percent of its pre-invasion foreign reserves, a rapid liquidation that forced the state to borrow $5.5 billion in a syndicated loan from the international market,7 and to use export credits from the Western countries. The ceiling on public debt was lifted from KD 3 billion ($10 billion) to KD 10 billion ($33 billion).
During the first three years after liberation, Kuwait incurred an accumulated deficit amounting to KD 14.4 billion ($48 billion). In the following years, 1993-94 and 1994-95, the deficit leveled out to around KD 1 billion ($3.3 billion) a year. Kuwait now has accumulated an outstanding debt (domestic and international) amounting to KD 9.9 billion ($33 billion).8 This cost is reflected in the government budget and the size of the deficit.
The Kuwait government erroneously believes that the country's current budget deficit results from the decline in oil prices and the costs associated with the Iraqi invasion-implying that the budget deficit will disappear when the bills for reconstruction are paid and the price of oil rebounds. In other words, some reduction in government spending will return Kuwait's financial situation roughly to where it was before August 2, 1990.
To the contrary, a permanent change has occurred in Kuwait's economic situation, and for several reasons. First, existing laws and decrees make it difficult quickly to turn off such benefits as housing loans and child allowances.
Secondly, government expenditures since 1960 have had a paramount role in generating resources for the population, so that a mentality of dependence has evolved.
Thirdly, to make matters worse, the government increased its spending in the aftermath if the Iraqi occupation, both to repair widespread destruction and to shore up its vulnerable political position. As a result, expenditures in the first two years after liberation (which came to 1.52 billion in Kuwati dinars [KD], or $5.16 billion) exceeded the total government spending over the twenty year period 1960-1980 (which came to just KD 1.32 billion, or $4.36 billion). This dramatic increase in spending led many Kuwaitis to expect yet more entitlements, making it all the harder for the government to reduce spending.
Fourthly, reopening the National Assembly in October 1992, after six years' closure, put greater pressure on the government to spend. To implement their political platforms, assembly members seek to increase benefits; and the government will likely agree with at least some of their proposals.
For these and other reasons, recent efforts to reduce spending have been insufficient. Current expenses and military outlays continue to rise above pre-invasion levels, and whatever reductions have come are in the area of capital expenditures-a shortsighted move, for such outlays play a key role in future economic growth.
If Kuwait continues on its current course, it will face unsustainable levels of deficit over the next decade, meaning that these might threaten not just the social fabric of the society but the very sovereignty of the country.
DETERMNING FACTORS IN KUWAIT
Kuwait has an estimated oil reserve of more than 94 billion barrels, translating into a per citizen oil wealth of 142,000 barrels, which at today's levels is worth $2.1 million per person. Nonetheless, this wealth is threatened by a range of factors, including high population growth (leading to a decline in per capita wealth), non-OPEC oil discoveries, advancement of oil extraction technology, and the uncertainty surrounding demand for oil, especially from the industrial world.
The following major factors could affect the financial situation over the next decade:
Political stability. Uncertainty and tension in the Gulf region has an immediate impact on Kuwait's financial situation. In October 1994, Saddam Husayn moved Republican Guards toward the Kuwaiti border, and the ensuing mini-crisis cost Kuwait around $500 million (a figure that includes payments to mobilize allied troops). Further, political problems affect capital outflow, domestic economic activity, and the flow of oil. Hence, issues like the future of Iraq, relations with Iran, and the Arab-Israeli peace process have a substantial effect on Kuwait's financial situation.
Oil revenues. Most energy forecast studies predict that oil prices will be stable at the $15 per barrel level in the short term.9 They also predict that world demand for oil, especially in Asia, will continue to increase. But these studies are narrowly based on quantitative models and virtually ignore political factors, thus making them of questionable value.
Even though Kuwait has developed its oil-production capacity to 2.5 million barrels per day (bpd), it still adheres to the 2 million bpd quota set by OPEC in November 1993. To make up for the decline in the price of oil and for the OPEC ceiling, Kuwait seeks to increase the value it adds to each barrel by increasing its refining capacity and expanding its presence in downstream industries (such as the Q8 gasoline stations in Europe). Given likely future increases in world demand, Kuwait's oil revenues are likely to remain around their current levels or increase; even so, they will not suffice to cover growing public expenditures.
Income from financial reserves. Kuwait's foreign reserves have plunged from their pre-invasion level, estimated at KD 34 billion ($113 billion), to a mere KD 14 billion ($46.7 billion), largely due to the expenses related to liberation and reconstruction; in addition, $5 billion was lost due to mismanagement, corruption, and embezzlement, particularly in Groupa Toras in Spain. Despite this precipitous decline, the continuing budget deficit means that these assets are being drawn down further to finance the public debt. Since 1993, the withdrawal has been about $7 billion a year. At the present level of liquidation the reserves will be gone in less than ten years. On the other hand, stemming these withdrawals would mean that foreign reserves bring (at 5-6.5 percent) an annual return of about $2 billion.
Military spending. Kuwait contributed KD 6.5 billion ($21.6 billion) to Operation Desert Storm, then (by the end of 1994) signed arms purchase agreements worth $5-6 billion. In 1994, the National Assembly approved a supplementary defense budget of KD 3.5 billion ($11.7 billion) over a twelve-year period and it is thought10 that 60 percent of this supplementary budget is already spent. This military spending excludes salaries for sixteen thousand persons in the military forces (which comes to KD 300 million, or $1 billion) and other nonweapon spending.11 In all, Kuwait spent $3.5 billion on defense and security in 1994-95.
Although Kuwait is facing difficulties trying to maintain such high levels of military spending, internal and external pressure will probably keep it unchanged. On the other hand, the National Assembly and the public are demanding that the government link its military spending to a clear military strategy rather than political reasons. Furthermore, the government must bring an end to corruption and kickbacks in the arms deals, which have become known to the public.
Government spending. Government expenditure is the key factor determining the size of future budget deficits. While total expenditures are down, current expenditures (mainly wages and salaries) continue to rise. Wages and salaries in the current budget amount to more than KD 2 billion ($6.7 billion) and represent 47 percent of the total expenditure; they consume, in other words, more than 80 percent of oil revenues. Kuwaiti citizens mainly benefit from this spending, as 93 percent of the 160,000-strong Kuwaiti labor force working for the government. Turned around, they compose 63 percent of total government employees. Six to ten thousand Kuwaitis will enter the job market every year for the coming ten to fifteen years, so wage and salary spending will continue to grow.
Government transfers (subsidies and transfer payments) are also growing due to increasing numbers of beneficiaries and a rise in the cost of the services provided (mainly education, health, and housing).12
Should the government decide to continue providing jobs and subsidies, the demographic character of Kuwaiti society necessitates that its spending continue to rise. With a population growth rate of 3.5 percent, the Kuwaiti population will double in about twenty years; even today, 55 percent of the Kuwaiti population is age eighteen or under.
The government also needs to bring structural change in the budget by reducing current spending and increasing capital spending; by redefining its role in the economy and reducing subsidies; and by encouraging Kuwaitis to work for private employers, not the state.
The political climate is likely to present a major obstacle to the adoption of such drastic policies, especially with 1996 being an election year for the National Assembly. The government does not want to give opposition candidates a target, and especially not those who focus on governmental mismanagement.
PRIVATIZATION, THE ONLY WAY OUT
To deal with this emerging crisis, Kuwait needs structural reforms that emphasize long-term development, not short-term welfare. The government must gradually reduce welfare benefits and subsidies, reserving them only for the poor, and encourage private enterprise to play its historical and natural (in other words, its pre-oil era) role.
There is only one solution: the government must design and implement a privatization strategy. This will do several positive things: increase efficiency, create productive job opportunities, and prepare national private companies to compete internationally. The Kuwaiti government in 1993 commissioned the World Bank to develop a privatization strategy and, as part of this effort, it sold its ownership in sixteen companies to the public, generating KD 370 million ($1.23 billion) in less than two years. While the National Assembly is preparing legislation to regulate the privatization process, the government has postponed privatizing the truly major corporations, such as the telephone and the electricity companies. The government is also allowing Kuwaiti and foreign companies to participate in downstream oil industries; a planned $2 billion petrochemical complex will include a 40 percent share for Union Carbide and 10 percent for other private firms.
Westerners must know these circumstances, and, instead of encouraging a militarization of the society, help to build a civil society with increased popular participation. By supporting political reforms, the West in general and the United States in particular will be making a sound long-term investment, as such reforms will help build domestic stability in the Gulf states. The trouble is, of course, that the U.S. government fears that unleashing such reforms will cause instability; it prefers, in other words, to risk the long term for quiet here and now. This is only human; politics is about today, not tomorrow.
It is also high time for Westerners to stop seeing the GCC states as cash cows. Lacking both the financial ability and the absorptive military capacity, they cannot continue to purchase arms as they have in the past. Further, GCC leaders must learn that their national security must be a collective effort with the other GCC states -- that, after all, is what the organization was set up for -- not a solo effort.
The West can play a constructive role by helping to shift GCC attention inward; the real threat lies within their societies more than outside them. The decline in per capita income and the lack of political rights might lead to serious domestic opposition and thus to stability.
The United States should continue to enhance trade and economic ties with the GCC countries as a way to build on the ties begun during the Kuwait war. This means, first, that it substitute for the expected decline in military purchases with nonmilitary goods and services, and secondly, that it increase its share of exports to the GCC countries. Introducing U.S. technology and American specifications and standards to the Gulf region creates long-term linkages between the two economies, leading to a larger American role in the future infrastructure projects within the GCC countries.
1 Middle East Economic Survey, Feb. 5, 1996.
2 E.G.H. Joffe, "Relations between the Middle East and the West," The Middle East Journal, Spring 1994, pp. 250-67.
4 The Arab Monetary Fund, et al., The Arab Economic Report, Sept. 1995, p. 280.
5 The foreign population consists mainly of the labor force, who generally are not accompanied by their dependents.
6 For an excellent analysis of this problem, see Vahan Zonoyan, "After the Oil Boom: The Holiday Ends in the Gulf," Foreign Affairs, Nov.-Dec. 1995.
7 The repayments are in seven quarterly installments starting June 1995. The interest rate was set at fifty basis points above LIBOR. Four installments have been paid and three more payments will be paid every three months until the end of this year.
8 This includes KD 5 billion ($16.6 billion) in bonds for bad debt swap of banks, KD 2.8 billion ($9.3 billion) in outstanding public debt issues, KD 1.8 billion ($6.4 billion) in payment for syndicated loans, and KD 217 million ($724 million) in repayments to the official exports credit agencies.
9 Guy Caruso, "IEA World Energy Outlook to 2010," paper presented at the Middle East Petroleum and Gas Conference, Bahrain, Jan. 16-18, 1994.
10 According to reports provided to the National Assembly's Economics and Finance Committee.
11 Still, this accounting system is an improvement over what used to be; only in 1993 did the National Assembly pass a law including all military spending in the government budget. Prior to that, most arms purchase were made on off-budget accounts.
12 For example, the estimated cost of 60,000 requests for housing loans will reach an accumulated KD 4.2 billion by the end of the century.