How Saudi Arabia is planning a new economic era
There can be little doubt that the government is serious about economic transformation
On April 25, Saudi Arabia is expected to announce a comprehensive economic plan aimed at pivoting the kingdom away from its heavy reliance on oil. The much-touted creation of a $2 trillion sovereign wealth fund will be one pillar of this plan.
Another will be the National Transformation Program, which includes a wide variety of reforms, from tax increases to spending cuts. This strategic reform initiative will build on the multimillion-dollar advice of several prominent consulting firms, a preview of which was given in a December 2015 McKinsey report.
The many challenges facing Saudi Arabia are well known. But if McKinsey’s assumptions and calculations prove correct, then the magnitude of required reform is truly astounding. According to their report, “Even if the government were to freeze the level of public expenditure in nominal terms to contain the deficit and intervene in the labor market to stem rising unemployment by limiting the influx of foreign workers, these reactive changes would be insufficient to maintain current Saudi living standards or sound public finances.”
There can be little doubt that the government is serious about economic transformation. But how far and how quickly they can push reforms are two important questionsNathan Hodson
In other words, things are challenging. McKinsey’s baseline scenario requires two enormous policy shifts and still won’t save Saudi Arabia from severe economic hardship. Instead, it calls on the kingdom’s leadership to be even more ambitious, focusing their efforts on increasing labor productivity, building a stronger business environment, and managing finances sustainably. What McKinsey has proposed is nothing short of revolutionary. For example, under its full-potential scenario, the consulting firm presumes non-oil government revenue will increase more than ten-fold between 2013 and 2030.
Steps toward change
Saudi Arabia has already taken a number of steps toward reform. The Saudi Arabian General Investment Authority (SAGIA) has simplified licensing procedures for foreign investors. The government has raised the price of fuel and electricity. And the kingdom has also already begun raising money both domestically and internationally, in the midst of credit downgrades from major rating agencies. Meanwhile, Saudi leadership has also recognized that much more needs to be done, including fiscal consolidation and working to eliminate the budget deficit in the next five years.
However, there is reason to be skeptical about the government’s ability to deliver. As the Economist pointed out, “Saudi Arabia has promised reform before, only for its efforts to fizzle into insignificance. Its capital markets are thin and the capacity of its bureaucracy thinner.” It is much easier to pen a strategic plan than to execute it. Previous plans have often fallen far short of their goals. Productivity growth in Saudi Arabia has been low in recent decades. Even if the government can somehow take immediate concrete steps to make the business environment better functioning and more transparent and can also lop off unproductive government spending, overhauling the education system and reforming the civil service are monumental tasks.
Every piece of the elaborate reform puzzle comes with its own challenges. In order to have a real impact on housing and development, the tax on unused land must be accompanied by the execution of reforms in the mortgage market and on regulations. Meeting proposed deadlines to adopt international accounting standards seems nearly impossible given a shortage of qualified accountants in the kingdom and difficulties ensuring sharia compliance.
This is to say nothing of domestic political concerns. The government should simultaneously placate the princes, garner the support of the business community, and be careful not to upset or overburden the masses with new taxes, reduced subsidies, and fewer government jobs. There has already been some pushback from consumer groups about water prices. And while targeted cash transfers to low- and middle-income Saudis will help relieve some of the burden, the fact remains that Saudi citizens will still be asked to work harder in jobs that pay less than they are accustomed to.
There can be little doubt that the government is serious about economic transformation. But how far and how quickly they can push reforms are two important questions. It is one thing to call for improvement in government delivery, a breakdown of barriers in the private sector, and improved accountability. It is another thing to deliver on these promises. However, even if Saudi Arabia can pull off only a fraction of the proposed reforms and falls short of its lofty goals, it will be a meaningful start to real economic transformation.
Nathan Hodson is a consultant and PhD candidate in Near Eastern Studies at Princeton University, where he writes on the modern Saudi economy. He's conducted extensive fieldwork in the Gulf and has previously worked on a Jeddah-based project for the Gulf Research Center. A former Fulbright Fellow, he holds an MPA from Princeton’s Woodrow Wilson School.