The government has announced ambitious plans to boost private sector growth, including improvements in the business climate, in trade logistics, and in the application of the rule of law. In the IMF scenario—which is reportedly more conservative than government expectations—these reforms are expected to increase non-oil GDP growth by 3 points by 2020, for a total of 3.5 percent growth per year. This seems quite optimistic, given the large weight of government spending in fostering growth in the past; and it says little about the potential for medium term growth, because the growth model itself remains fuzzy and poorly defined. The question of interest is, therefore, what growth model can deliver a larger tax base? From a longer-term perspective, oil rents are not sufficient anymore to finance anything close to the current consumption levels of the population, and this can only get worse over time in the absence of a new source of growth. With its current population of 23 million, and oil revenues of only $6000 per capita, Saudi Arabia has clearly outgrown its current model. A new growth model would also allow consumption to grow again after a necessary adjustment, and a credible model could even justify a temporary smoothing of consumption until growth picks up again, fueled by a new economic reactor.
In the short term, growth will be made harder by the headwinds created by fiscal stabilization itself. Cuts in government expenditure create a drag on non-oil GDP growth, whose size depends on the size of the “fiscal multiplier”. The multiplier depends on how much of government spending ends up as imports and remittances—the larger these, the smaller the “multiplier”. It has been estimated, based on historical data that the short-term multiplier is quite low at about 0.5 (Espinoza et al. 2013). This means that large leakages reduce the growth impact of government expenditures. Still, one would expect a cumulative fall in the growth of non-oil GDP on account of a stabilization effort of about 10 percent of GDP to be about 5 percent points. Already, non-oil GDP growth, which was growing fast before the 2014 shock, has halted to about zero. The stabilization drag is expected to continue to operate for several years as firms adjust their level of operation to lower levels of government spending.
But what will drive economic growth in the medium and long terms? There are several reasons to believe that the main source of growth available in the medium term is the increase in the labor force participation of Saudi nationals.
From a tax collection perspective, GDP growth per se does not tell us much about the economy’s ability to absorb increased revenue collection, which depends not just on growth rates, but on the type of growth. A path of labor intensive growth leveraged on expat labor can allow for larger taxation of corporate profits, but if it does not manage to increase employment among Saudis, it would require more social spending to preserve social peace, and thus, would not be conducive to correcting the macro-imbalances. On the other hand, growth based on the expansion of Saudi labor would lead to a broader tax base over time.
More broadly, only 40 percent of working-age nationals participate in the labor force (but only 35 percent work, as the rest are unemployed). This compares to labor participation rates of about 60 percent in the OECD. Low Saudi participation rates are largely due to very low participation by women (19 percent), but men’s participation (55 percent) is not high by international standards either. Huge gains could be made if they were instead encouraged to do so, because Saudi nationals are both grossly underemployed and increasingly well educated, thus increasing the opportunity cost of low participation. To give a sense of the potential gains if national labor was employed more effectively, a simple projection model suggests that, with participation rates growing from 40 to 60 percent of the working-age population and unemployment dropping to its natural rate, non-oil national income would more than double if the additional workers join the non-oil sector at current productivity levels. Improvements in labor productivity would add to this growth rate further. Altogether, it can be estimated that this addition to national wealth is comparable in magnitude to the kingdom’s current oil wealth.
The extent of economic gain that can be obtained by fixing other inefficiencies, or by removing other constraints to growth, pales in comparison. The total cost of energy subsidies is about 7 percent GDP—there is certainly much over-consumption given low prices, but the extent by which the economic pie can actually be increased on this front is limited. Importing technology to increase productivity, the classical catch-up development policy, is desirable, but the reason for the relatively low labor productivity in the past has not been the lack of openness of the Saudi market to outside influences, but rather, the incentive of firms to use labor-intensive technologies, which is itself connected to the widespread availability of cheap (imported) labor.
This poses the question of the employability of Saudi citizens. Jobs cannot come from an expansion of the civil service. The government is no longer hiring all Saudis who are willing to work. And in the current economic environment, nationals are simply not employable in large numbers in the private sector. Already, unemployment is officially at 11.6 percent overall, 32.8 percent for women, and 29.4 for youth, and rising. Moreover, there are about 200,000 new entrants to the labor market every year.
One can envision a worst case scenario, where dwindling oil revenues continue to be shared among the nationals, cheap labor continues to be freely imported, and Saudi reservation wages only fall slowly over time as oil rents per capita decline. In such a scenario, the kingdom will turn into an increasingly impoverished welfare state, with rising unemployment and lower labor force participation. Moreover, income inequality would rise fast, as business-owners continue to enrich themselves by exploiting cheap expat labor, while the rest of the population gets poorer over time. Governance, which has relied largely on the co-optation of citizens, could become more repressive, as has happened in the countries of the region with smaller oil endowments and larger populations, such as Iraq or Algeria (Cammett et al. 2019).
Besides the no-reform slow-impoverishment scenario, an equally undesirable strategy is one that uses the existing fiscal space to finance a costly pie-in-the-sky national project that does not deliver sustainable growth. Some elements of the Vision 2030 can be read in this manner, and especially those that project Saudi Arabia to become a sort of Dubai on steroids, with Saudi youth managing a large population of migrant workers in a super-competitive knowledge economy. The challenge for such a strategy is to make middle-skill Saudi workers complementary to expat workers. Such a vision seems too ambitious at the macro level for a country the size of KSA. One can think at best of particular sectors, where such a production strategy can make sense, but it cannot cover the whole economy. But even then, insulating sectors with cheap foreign labor from others that employ higher skill national workers runs again in the same problem as with the current quantitative restrictions on labor use—the existence of cheap unskilled expats will reduce the incentives of firms to increase capital investment and improve efficiency and wages in the sectors selected for upgrades.
While the more pessimistic scenario is the more likely of the two, both fail to present a reasonable vision for the country’s next 20 years, when oil revenues are likely to remain sizable, but not sufficient to sustain the current model of development. It must be evident to many Saudis that it is high time for the productive structure to adapt to the new realities. The country’s human and real assets have changed profoundly in the past 50 years. While importing labor to build the country made sense in the past, there are now large cohorts of educated Saudis graduating and aspiring to productive employment. The situation is thus profoundly different, and it requires profoundly different economic incentives. The massive import of foreign labor was a response to an exceptional situation, unseen in these proportions in any other country at any other time. This period has now to come to an end.
To employ its youth gainfully, Saudi Arabia now needs to become a “normal” oil economy—like, for example, Norway—that exports mostly, if not only, oil, but that derives national income from the work of its own population, primarily in the service sector. In this “normal” model, Saudi workers would replace expatriates, largely in service jobs. The economy would remain dominated by a large oil sector (which includes backward- and forward-linked sub-sectors), employing specialized national workers (e.g., about 50,000 oil engineers). A large share of the Saudi labor force (say half) would remain employed in government; and many public-sector firms would continue to play an important economic role, employing specialized Saudi workers in the oil, health, academic, telecom, and finance industries.
The new jobs would largely be in high-productivity occupations in the service sector. Except in a few areas of comparative advantage, not many firms would produce globally competitive tradables; those that do so now would be unlikely to survive given that unskilled wages would rise, capital would come at a higher cost, subsidies would be cut, and taxes would be introduced. At best, a few tradable sectors could thrive, such as religious tourism and sectors with close linkages with petroleum—at least initially.
At the end of this transition, millions of expatriates would have returned to their home countries, having provided a vital contribution to the task of building up a modern country at record speed. The Saudi economy would become smaller, but it would employ a large share of its own population productively. At the end of the day, the 6 million expats working in private sector firms may be replaced by less than 1 million Saudi workers, employed at higher productivity and at higher wages. The private sector may shrink considerably—even as the tax base grows. The economy may end up with a lower GDP, but it would produce a larger national income. Oil would remain central, but it would have a much larger multiplier effect in terms of the domestic employment of nationals.
In sum, the main economic challenge of the transition to a normal economy is to create highly productive jobs for nationals. It is easy enough to create high-paying jobs—in the public sector, including the security forces, or by replacing migrants in labor-intensive private-sector occupations. But the first option (creating new public-sector jobs) would expand fiscal deficits unsustainably. The second option (replacing expatriate workers with nationals) can deliver high wages in the non-tradable service sector if the total number of migrant workers is reduced sharply. But unless productivity rises too, this would be reflected in higher non-tradable prices, eroding standards of living.
In spite of the relative complexity of the task ahead, one should keep in mind that the overall challenge remains modest—to find productive jobs for about 1 million Saudis over the next five years, in an economy whose GDP is close to $1 trillion. What is needed is a three-prong strategy that tweaks the time-tested Saudization strategy further, by moving faster and more ambitiously on increasing the cost of expat labor, and that supplements labor policies with an industrial policy that helps domestic firms adapt faster to a new set of input prices, and by a conducive macro environment that makes room for the necessary investment needed to raise labor productivity. The rest of the chapter explores each of these themes in greater detail.