The Externalities of Petroleum Sector in Saudi Arabia - Term Paper Example

The Externalities of Petroleum Sector in Saudi Arabia Number June 12, Faculty The Externalities of Petroleum Sector in Saudi Arabia Literature Review Defining the Concept of Externalities When individuals and organizations engage in activities for their sake, they affect other people outside their processes either positively or negatively. A negative effect on the environment and people accruing from some activity is referred to as a negative externality while a positive impact makes a positive externality. The activities of oil mining and refinery have far-reaching positive and adverse effects on both people and the environment (Bohi and Toman, 2012). In Saudi Arabia, these effects are of a higher magnitude based on the intensive production of oil in the country. The production of petroleum accounts for one of the most environment-polluting activity around the globe which results in adverse side effects on the environments ability to support life. The same activity, however, accounts for the greatest revenue generating activity for major oil producing countries of the world including Saudi Arabia. The production of petroleum thus can be said to impact both positively and negatively on both people and the environment. The Background of Petroleum Production in Saudi Arabia Saudi Arabia is the leading oil producer and exporter in the world. With its petroleum-based economy, Saudi Arabia’s oil accounts for about 75% of the government revenues and 90% of the country’s total exports. The petroleum sector in Saudi Arabia contributes about 45% of the country’s Gross Domestic Product compared to the 40% contribution by the private sector (Alshehry and Belloumi, 2015). The Per Capita GDP in the country is estimated at $20,700. Despite the efforts for diversification in the petrochemical sector, the economy of the country remains highly dependent on oil in the second decade of the 21st century. As of 2011, Saudi Arabia produced approximately 10.782 million barrels of petroleum daily with a greater portion being exported. Domestic consumption of oil to generate electricity has been on the increase over the years. The country has the largest crude oil reserves in the world that account for about 18% of the world reserves as reported by the Organization of Petroleum Exporting Countries. Positive and Negative Externalities of Petroleum Sector in Saudi Arabia Saudi Arabia can economically be said to be a rentier state given that it depends on externally generated rents as opposed to the surplus production of its population. The categorization of the country as a rentier state is evidenced by the percentage of its petroleum rents in terms of total government revenues. As a rentier state, the rent-seeking behaviour is characteristic that cuts commonly across the public and private sector (Al-Thukair, Abed and Mohamed, 2007). The rent –seeking behaviour involves both legal and illegal means of acquiring control over rent earning opportunities. Such conduct engages economically unproductive ways of obtaining oil money that is controlled by a few individuals exposing a larger population to poverty and poor living standards. In general, the levels of corruption and amassing of wealth by the minority in oil producing countries have been on the increase over the years. Such has resulted in civil wars, political instabilities, abject poverty levels and subsequently human suffering. The petroleum sector in Saudi Arabia has a significant potential for enhancing the creation of jobs, increasing the rate of economic growth, increasing revenues, and the improvement of infrastructure. Further, the potential transfer of technology, the growth of the infrastructural development and boosting of other related industries add on to the list of benefits (Campbell, Niblock and Looney, 2015). The increase of government revenues increases the ability and power to alleviating poverty and improving the living standards of the citizens. These benefits point to the positive externalities that can accrue from the petroleum sector in Saudi Arabia. However, the reality may be different. Few of these benefits are experienced in many oil-producing countries of the world. The negative consequences of the Saudi petroleum led-economy are many and have far-reaching effects. Such an economic approach imposes barriers to economic diversification in the country and results in a slower than expected growth rate. Poor social welfare performance, inequality, environmental degradation, unemployment and high levels of poverty are part of the negative consequences (CROSS, 1992). Due to its oil led-development, Saudi Arabia is characterized by high levels of corruption and poor governance coupled with a rent-seeking culture. These attributes impose devastating health, economic and environmental consequences at the local level increasing the chances of war and conflict. On the negative side, the expansive petroleum sector in Saudi Arabia has made the kingdom one of the most authoritarian, economically troubled and conflict-ridden nations in the world. Positive Externalities and their effects on People’s lives Although not directly involved in the management or running of the petroleum sector, the Saudi nationals benefit from the expansively large oil industry. Firstly, the petroleum sector in Saudi Arabia forms one of the most important job-creating industries. The people that work in the mines for both the technical and non-technical skills account for a considerable percentage of employed people in the country (Dincer, Hussain and Al-Zaharnah, 2004). Citizens also get used by oil transporting agencies. The employment further increases through a created potential for other related manufacturing industries. The expansion capability of other sectors that emanates from the existence of a large petroleum industry increases the employment capacity of the people of Saudi Arabia. That way, the oil industry provides a critical mechanism for addressing the high unemployment rates existing in the country. The existence of the petroleum sector in the country poses the positive consequence that peoples incomes increase pushing the level of investments in other different industries upwards. As the chief government revenue earner in Saudi Arabia, the petroleum sector induces the positive externality of potential improvement of living standards and alleviation of poverty. The government is the representative of the ordinary people and acts on the behalf of the citizens (Dinçer, 2014). The high revenues that accrue from the exports are used by the government on development projects that are geared towards the improvement of peoples welfare. There is a high Per Capita Income for every individual citizen and hence the possibility to improve the living standards. The increased government capacity to embark on several development agenda helps steer up the countrys economic growth that further improves the peoples status and living standards through increased incomes. The petroleum sector in Saudi Arabia has a high potential for infrastructural development in terms of road and railway networks in the country. Economically, an improvement of the infrastructure boosts the growth of business activities and helps improve the peoples livelihood (Moser, Swain and Alkhabbaz, 2015). The economic activities such as investments highly depend on the state of infrastructure. Infrastructural development, therefore, further attracts local and foreign investments increasing the level of job opportunities for the locals. In terms of environmental protection, the high revenues that accrue from petroleum sector increase the government’s ability to embark on projects that aim to protect and improve the environment. Negative Externalities and their effects on People’s lives Like any other oil producing and dependent country around the globe, Saudi Arabia suffers from the ‘Resource Curse.’ The resource curse stems from the inverse association between the dependence on the petroleum sector and economic growth. The situation has been a constant motif in the economic history of Saudi Arabia. According to the reports by OPEC, the Per Capita GNP of the several member countries including Saudi Arabia declined by at least 1.3 percent in the period between 1965 and 1998. On the contrary, middle-income countries developed by at least 2.2 percent during the same period (Samargandi, Fidrmuc and Ghosh, 2014). The resource curse has negatively affected the economic growth of Saudi Arabia to the effect that peoples lives are adversely affected. During the global petroleum windfalls, various sectors of the economy in the country get hurt when the real exchange rates are pushed high making other exports non-competitive. The resultant factor is the ‘Dutch Disease. The agricultural and manufacturing sectors competitiveness in Saudi Arabia have severally been affected crowding out other productive sectors and, as a result, economic diversification becomes difficult. The net effect of these occurrences is the reduction in the quality of life that people should lead. The petroleum sector in Saudi Arabia is characterized by price volatility and long-term price deflations, which to a great extent hinder economic development. The frequent economic shocks experienced in the area create attendant problems with an acute susceptibility to boom-bust cycles. Such price volatility negatively influences the control of public finances and the countrys budgetary discipline. As a result, real economic performance deviations from the planned performance have gone as high as 30% in the recent past. Consequently, a negative pressure is exerted on income distribution, investments and poverty alleviation (Grant, 2013). There are relatively weak linkages between the petroleum sector and other economic sectors in Saud Arabia associated with lack of a significant multiplier of growth in this sector. The industry has adopted capital-intensive measures of production to the effect that job opportunities are narrowed down creating a room for increased poverty levels. The existence of inadequate health care, poverty, high mortality rates among children and the poor educational systems in Saudi Arabia are contradictory effects of ‘resource curse.’ The rent-seeking culture and high levels of corruption arising from the dominant petroleum sector confine the resources within the minority (Grant, 2013). Development is negatively affected, and the majority of the populations are rendered destitute and coerced to live below the poverty lines. The adverse impacts of petroleum dependence in Saudi Arabia on economic diversification into self-sustaining activities in the labour-intensive industry such as agriculture prevent the pro-poor development. As a result, the living standards of people have declined dramatically despite the increase in Per Capita income. Children mortality rate in Saudi Arabia has been on the rise hitting a 3.8 per thousand points for every 5-point increase in dependence rate. The intensive manufacturing of petroleum in Saudi Arabia with dislocations, higher levels of conflict, health and environmental hazards in many oil localities. Lack of sustainable employment alternatives in the sector combined with the immigrations of people into the oil producing zones inflates the prices of critical services and goods. In effect, the cost of living increases indiscriminately (Bohi and Toman, 2012). The seasonal nature of jobs in the petroleum sector is associated with high opportunities during the exploration phase that diminish over time. Significant environmental pollution in Saudi Arabia is associable to the oil industry. The problem of site contamination, production of hazardous wastes and air quality and biodiversity reduction has harmful effects. The Ozone Layer depleting substances are emitted into the air during oil manufacturing and refinery (Taher & Hajjar, 2013). Trees and natural vegetation are cleared to pave the way for the expansion of petroleum production and infrastructural development. Consequently, the health of local populations and aquatic life is put at stake. Many people have been reported to die of air-borne diseases that emanate from weak protective measures. The Middle East region, in general, has constantly been in a state of war and conflicts in the struggle for oil resources. These instabilities have affected the quality of human life in these regions to the effect that lots of lives have been lost, and people experience insecurity and lack of peace (Alshehry and Belloumi, 2015). Economic activities are adversely affected by wars and conflicts, and particularly economic development slows down with decrease productivity. These aspects result in human suffering and have persistently affected peoples lives. From the analysis of externalities, it is evident that the negative externalities of the petroleum sector exceed the positive externalities in both magnitude and number. The majority of the positive externalities are temporal and only experienced for a short period after, which they lapse (Ramady, 2005). The negative externalities however, extend their influence over long durations of time. Economically, Saudi Arabia is put at stake by the negative externalities that may deter any further economic growth efforts of the country. The real GDP and exchange rates would keep declining in the future. Long Term and Short Run Externalities Some externalities take time to have real effects on the people and the environment. Their impacts are far reaching and influence lives of many generations. These are the long-term externalities and include civil wars, conflicts, political instabilities, environmental pollution and infrastructural development (Kaul & Conceição, 2006). These externalities have both positive and negative impacts that affect people’s lives for a lengthy period of time stretching from generation to generation. However, some externalities have effects that affect people in the short run. These include the temporal creation of jobs, increased economic growth rate, the increase in government revenues and the transfer of technology. These externalities have impacts that hardly remain for a full year. Examination of Saudi Arabia’s possibility of experiencing the ‘Dutch Disease. The causal mechanisms of the ‘resource curse are debatable and are attributable to many factors. In Saudi Arabia, the windfalls experienced within the petroleum sector have a significant potential of hurting other sectors. Consequently, the countrys real exchange rates are expected to rise on such occasions. Most other exports from the agricultural and manufacturing sectors would most likely become less competitive in the international market. The manufacturing and agricultural sectors in Saudi Arabia have been declining with the increase in the ever-expansionary petroleum sector (Campbell, Niblock and Looney, 2015). The greater percentage of the government revenues in the country accrues from oil exports. In effect, the currency of the nation has appreciated over time making the manufactured and agricultural exports expensive in the international market. Imports have gradually become cheaper, and thus demand for the countrys manufactured and agricultural commodities has kept declining globally. Such a situation was experienced in Netherlands in 1959 following the discovery of natural gas fields at Groningen. The economists came to refer to the situation as the ‘Dutch Disease. Saudi Arabia’s situation is not very different from that which was experienced by Netherlands and bears the risk. However, the appreciation of Saudi Arabias real exchange rate could be resulting from several other factors and hence it is difficult to judge with certainty its possibility of having the Dutch Disease. Lowering the real exchange rates and boosting the agricultural and manufacturing sector could help alleviate the chances of the disease (Dinçer, 2014). Proper management and macroeconomic policies that strike a balance between the sectors can help Saudi Arabia avoid the ‘Dutch Disease like the case was in Norway. Positive externalities should be encouraged and subsidized while the negative ones should be highly taxed to ensure that the costs imposed on the people and environments are compensated. Applying the Model of Externalities The model of externalities may be said to involve three key issues. These are residuals, intangibles and incommensurables. The residuals involve the pollution of the environment and wastes that are produced by the petroleum sector (Tresch, 2002). Such include the carbon II oxide that is produced to the air, the noise and the oil spillage into water masses. The intangibles are effects that cannot be assigned any monetary value. Such include the human suffering that results from negative externalities. The incommensurable are effects that can be assigned some monetary value with some certainty and hence taxable. The model of externality provides for the recovery of social costs. The recovery is achieved in the form of general sales taxes that are imposed to compensate the effects of the residuals. The polluter and consumer pays principle is used to compensate the negatives of residuals that arise from the manufacture, refining and use of oil. In order to make proper environmental planning, the cost effectiveness and Benefit-Cost analysis are conducted. The costs of the externalities and their benefits are considered in order to establish a break even. These analyses are achieved by quantifying the externalities, which involves the assignment of prices on the incommensurables (Tresch, 2002). Where multilateral externalities exist, the principal-agent model is applied. Such involves the willingness of the polluters to pay for the negative effects of the externalities they pose to the environment and human population. The sector in this case is a principal who can use subsidies to incentive the consumers who are the agents to ensure reduced negative effects. The principal-agent model is applied to reduce the emissions into the environment. References Alshehry, A. and Belloumi, M. (2015). Energy consumption, carbon dioxide emissions and economic growth: The case of Saudi Arabia. Renewable and Sustainable Energy Reviews, 41, pp.237-247. Al-Thukair, A., Abed, R. and Mohamed, L. (2007). Microbial community of cyanobacteria mats in the intertidal zone of the oil-polluted coast of Saudi Arabia. Marine Pollution Bulletin, 54(2), pp.173-179. Bohi, D. and Toman, M. (2012). The Economics of Energy Security. Dordrecht: Springer Netherlands. Campbell, J., Niblock, T. and Looney, R. (2015). State, Society and Economy in Saudi Arabia. Foreign Affairs, 60(4), p.973. CROSS, A. (1992). Monitoring marine oil pollution using AVHRR data: observations off the coast of Kuwait and Saudi Arabia during January 1991. International Journal of Remote Sensing, 13(4), pp.781-788. Dincer, I. (2014). Progress in sustainable energy technologies. Cham: Springer. Dincer, I., Hussain, M. and Al-Zaharnah, I. (2004). Energy and exergy use in public and private sector of Saudi Arabia. Energy Policy, 32(14), pp.1615-1624. Grant, S. (2013). Cambridge International AS and A level economics. Cambridge: Cambridge University Press. Moser, S., Swain, M. and Alkhabbaz, M. (2015). King Abdullah Economic City: Engineering Saudi Arabia’s post-oil future. Cities, 45, pp.71-80. Samargandi, N., Fidrmuc, J. and Ghosh, S. (2014). Financial development and economic growth in an oil-rich economy: The case of Saudi Arabia. Economic Modelling, 43, pp.267-278 Kaul, I., & Conceicao, P. (2006). The new public finance. New York: Oxford University Press. Ramady, M. (2005). The Saudi Arabian economy. New York: Springer. Taher, N., & Hajjar, B. (2013). Energy and environment in Saudi Arabia. Tresch, R. (2002). Public finance. Amsterdam: Academic Press. Read More