Oil Resources Availability in Saudi Arabia - Essay Example

Examining the Impact of Oil Resources Availability on Economic Growth in An Oil-Based Economy with reference to Saudi Arabia Literature ReviewWhen oil was recently discovered off the coast of Sao Tome, it immediately generated a short term coup for benefits from oil resources, so that the Prime Minister Maria das Neves stated: “Oil could be our heaven, purgatory or hell; it all depends on how Sao Tome faces up to this challenge.” (Agence France Presse, 2004). The natural assumption that the availability of a rich natural resource such a soil would automatically entitle a country possessing it to affluence therefore appears to be belied by the statement of the Prime Minister of Sao Tome. In the case of Saudi Arabia, the availability of rich oil resources has brought untold affluence to this tiny nation, however despite this, economic growth has been slow since the eighties and there has been increasing unemployment, with the unemployment rate among young Saudis estimated to be between 8 to 13 percent. The question of how such a situation could have developed in a country rich in natural oil resources is examined below. The Petroleum Sector in Saudi Arabia comprises roughly 75% of budget revenues, 45% of its GDP and 90% of its export earnings (www.e.wikipedia.org). Saudi oil reserves are estimated to be the largest in the world – about 260 billion barrels - and the country is the world’s largest exporter, with oil comprising 95% of the country’s exports and almost 75% of government revenues (www.en.wikipedia.org). In view of the country’s heavy dependence on oil, the Government has recently begun to encourage more development in the private sector, including in the power generation and telecom sectors. Saudi Arabia has also joined the WTO in 2005, in order to enhance its trading, diversify its economy and attract a higher proportion of foreign investment. The Government has also been spending larger amounts on infrastructure development, job training and education. History: Oil was first discovered in Saudi Arabia in the 1930’s, by U.S. geologists. Oil production in Saudi Arabia soared in the 60s and gave rise to a period of strong economic development which continued into the 1970s.(www.en.wikipedia.org). During the Seventies, there was an oil boom and the Gross Domestic Product per capita of Saudi Arabia soared, reaching a figure of 1,858%, however such growth was unsustainable and shrank to 58% in the eighties, although it has registered a 20% increase in the nineties.(www.earthtrends.wri.org) Most of the oil in the country is produced on behalf of the Saudi Government by a single Company, Saudi ARAMCO. After the 1973 Arab Israeli war, there was a sharp rise in petroleum revenues, which contributed to Saudi Arabia’s rise as one of the fastest growing economies in the world. At the height of the oil boom in the late 1970s and early 1980s, the average per capital income in Saudi Arabia was about $17,000. Trade surplus was the result and the Government had abundant reserves to channelize into development and defense and in providing aid to other Arab countries.(Saudi Arabian Monetary Agency, Annual Report). However, the situation changed in the eighties, as rising oil prices led to a reduction in global oil consumption and the development of more oil fields around the globe. There was a worldwide glut in oil, which introduced an element of uncertainty into the oil economy. (en.wikipedia.com). Saudi oil production, which was about 10 million barrels a day dropped to 2 million barrels a day by 1985, which contributed to budgetary deficits in the Saudi economy. Furthermore, a relatively stable level of oil production combined with fluctuating oil export revenues, with a simultaneous growth in population impacted negatively on the Saudi economy and its per capita income continued to decline, dropping to $12,300 in 2003, thereby lagging behind most Gulf countries. (Saudi Arabian Monetary Agency, Annual Report). Saudi Arabia had to re-negotiate its role as the swing producer among the OPEC countries and accept a limited production quota, while oil prices have also continued to decline due to a variety of other factors such as the East Asian economic crisis in 1997, and El Nino in the West that produced a warm winter.(en.wikipedia.org). However Saudi Arabia has also been a part of a successful oil campaign that was launched by the OPEC countries to raise oil prices through effective management of the production and supply of petroleum. Due to the increase in oil prices in recent times, the per capital income in Saudi Arabia has gradually increased, to reach $15,500 in 2006.(Saudi Arabian Agency Monetary Agency, Annual Report). Natural resources and the economy: The world’s economy and technological infrastructure is dependent to a large extent upon the availability of abundant supplies of cheap oil. However, with continued growth in demand during the next 10 to 20 years, without the means to supplement with the actual endowment in world oil resources, the result may be a steep and sudden decline in the supply of oil. (Alum, 2002). Therefore, it appears that the temporary rise in per capita income in Saudi Arabia may be in danger of a further downslide, as alternatives to oil resources are developed. The measures taken by the Saudi Government to improve infrastructure and other sectors of the economy. The predominant economic growth theories of the second half of the 20th century were based on the axiom that a limitation in the supply of fossil fuels on which the economy is based will not constrain growth, on the basis that the market will ensure that there is a smooth transition from oil based fuels to non conventional resources such as oil sands and oil shale as well as the conversion of natural gas, without any major unfortunate impact, either for affluent or poor societies.(Alum, 2002). However, such a move could only spell further declines in the predominantly oil based economy of Saudi Arabia, thereby necessitating other measures by the Government to promote economic growth on the basis of other sectors of the economy. However, the important question that arises in this context is the anomaly of poor economic growth in a country like Saudi Arabia with such a rich base of a natural resource – oil. In some instances the resource abundance may become a source of problems rather than being a part of the solution to aid in development. Due to the abundance of the natural resource, like oil, the country’s economy becomes largely export centered, as a result such an export concentration is associated with weak public institutions. Several studies that have utilized cross sectional data have shown the connection that exists between institutions and economic growth, such that weaker public institutions are associated with slower economic growth (Rodrik and others, 2004; Rigobon and Rodrick, 2004). These studies have shown that the pace of economic development is generally higher in the western nations largely due to the nature of the institutions that are in place, which focus upon the maintenance of strict law and order and the promotion of free enterprise. The Governments in these countries have focused upon the development of a wide industrial base with due attention being paid to the development of adequate infrastructure for the development of industry and commerce. Since these are largely democratic institutions, there is free enterprise and market forces operating within these countries in conjunction with a well developed law and order system, which helps to facilitate economic growth. The weakness of the institutions in Saudi Arabia may be one of the significant reasons for its decline in economic growth. Over the past decade, there has been a significant body of research which has suggested that the path of development that occurs within any country is largely shaped by the nature of its institutions, which in turn arise on the basis of the history and geography of those nations (Acemogulu and others, 2002, 2003; Easterly and Levine, 2002). These authors have pointed out the differences in the economies of the Western nations and the developing nations which were once colonies. The existence of abundance of a particular resource or endowment within a particular country during the colonial period often resulted in the colonial powers or an expatriate minority seeking to build the kind of Government structure that was geared towards the subjugation or control of the majority domestic population. As a result, the kind of institutions that were put into place were not strong and effective, but targeted towards serving the interests of the minority colonial powers that controlled the country. In the case of Saudi Arabia, a similar kind of colonial situation exists where the country is largely under the control of the minority royal family, with developments in the country being targeted around the interests of the family rather than the majority public. The political constitution of the Country may have a great deal to do with the weaknesses of its institutions. The country of Saudi Arabia is a monarchy without any elected political parties or representative institutions. The country is ruled by King Fahd bin Abd Al Aziz Al Saud, but since his stroke in 1995, the crown prince Abdullah has been the de facto ruler of the country.(www.state.gov). Religion is an integral part of Saudi institutions and it is the Basic law as set out in the Koran that forms the basis for the Government, the rights of the citizens. The Constitution of the country is based upon the Sunni Muslim tradition and being the custodian of two of Islam’s most sacred shrines – Mecca and Medina, the Government bases its legitimacy upon governance in accordance with the Islamic law.(www.state.gov). All government and political institutions are mostly controlled by the minority royal family, for example, the Crown Prince controls the National Guard while Prince Sultan is responsible for all the military forces. Responsibility for internal security and law and order are under the control of the Ministry of the Interior and constitute a religious police force which ensures that citizens follow the principles of Islamic law (www.state.gov). The sudden onset of the oil industry was the basis for the transformation of the Saudi economy from a largely agricultural , pastoral and trading society into an urbanizing one with a high percentage of foreign workers who migrated into the country to provide cheap labor. Agriculture now constitutes only 6% of the economy and 40% of the economy is private with the human rights record of the Government remaining poor (www.state.gov) and certifying to the weakness of its institutions, which do not provide an effective forum for the development of free enterprise and a fair and equitable legal system. Van der Plog (2007) examines the political economy of resource rich economies and points out that empirical evidence appears to suggest that countries which have a large share of their primary exports in GNP have records of bad growth and inequalities, especially when the quality of the institutions and the rule of law are bad. He also points out that such resource rich economies tend to squander away their natural resources and do not post high savings rates. In his analysis, Van der plog (2007) raises the interesting question of why certain countries with rich natural resources, such as Canada, Australia and Norway perform very well in terms of economic growth while other resource rich economies are not able to perform well despite their immense natural wealth. He provides an econometric analysis in order to answer this question through a case study analysis of several countries. One of the notable examples in this context is that of Nigeria which also has abundant oil reserves like Saudi Arabia. Nigeria has been a major oil exporter since 1965 and its oil revenues per capital have jumped from 33 million U.S. dollars in 1965 to 325 million U.S. dollars in 2003. Yet the income per capital in Nigeria remains so low that it ranks among the 15 poorest countries in the world. The reason for this lies in the under utilization of capital resources and the rampant corruption of the military dictatorships which have plundered the oil wealth so that it rarely trickles down to the average Nigerian. Van der plog (2007) points out that other oil exporter countries such as Iran, Kuwait and Venezuela have also experienced a decline in economic growth and GNP per capita. Gylfason(2001) argues that the reasons for such declines in economic growth may lie in the fact that an abundance of natural capital tends to crowd out investments in human capital, and the natural extension of this is a slowing down in economic development. He has supported his argument statistically by showing that a decline in public education relative to national income, as well as reduction of years of schooling for girls or the lack of provision of secondary education are all factors that are inversely related to the natural capital in wealth across countries. He argues that “nations that are confident that their natural resources are their most important asset may inadvertently – and perhaps even deliberately! –neglect the development of their human resources, by devoting inadequate attention and expenditure to education.” (Gylfason, 2001:850). In the case of Asian countries as well as Saudi Arabia, such a deflection from education is likely to be the case. As pointed out by Van der Borg (2007), resource rich Asian countries such as Malaysia, Indonesia and Thailand have managed to improve their GDP and maintain economic growth through diversification and industrialization, rather than relying solely upon the natural resource to fuel their economic growth. These Asian countries do not focus upon educating their female population and in this aspect are directly contrasted with the economically more successful Western economies where female literary is high. This could serve to partly explain lower rates of economic development in these countries, due to the lower proportion of investment in human capital, as pointed out by Gylfason (2001). While the Asian countries mentioned above, like Thailand and Malaysia, have tried to offset this trend through diversification and industrialization, this has not been the case with Saudi Arabia which remained largely chauvinistic during the 1970s and focused only upon its oil based growth, to the detriment of other sectors of the economy which were ignored or remained undeveloped. This could serve to explain the reasons for the decline in economic growth which resulted in Saudi Arabia, despite the abundance of its natural oil resource. In pointing out the significance of the institutional framework within countries as a factor that influences the degree of economic growth, Van der borg (2007) contrasts Nigeria and Norway, both countries with oil rich resources. However, while Nigeria remains one of the poorest countries on the world with a low per capita, Norway is a country that has shown a remarkable amount of growth in other sectors of its economy such as manufacturing, despite the fact that it has an abundance of oil exports. Therefore, Norway has diversified its economy and this has contributed to its economic growth, which is not solely dependant upon the vagaries of the oil market. However, one of the more important reasons for the higher economic growth in Norway is the quality of its institutions – corruption is very low in Norway, as a result of which wealth earned by the country in terms of its exports are funneled back into channeling the country’s growth rather than being diverted to line the pockets of greedy politicians as is the case in Nigeria, where large amounts of oil revenues have been siphoned off by the dictatorial regimes rather than trickling down to benefit the average Nigerian. While applying this to the case of Saudi Arabia, it must be noted that the institutional framework in Saudi Arabia is structured to benefit the royal family and a small group of private enterprises. The institutional framework is geared upon religious principles of maintaining the rule of law in accordance with Islamic principles enshrined in the Koran rather than economic principles including diversification and development of fairness and equity in law, with an outreach to the general public, which could result in higher levels of growth. For example, Van der borg(2007) has also mentioned how the manner of utilization of mineral resources by the United States during the period of the mid nineteenth to the mid twentieth centuries serves to explain its later high levels of economic development. In the case of the United States, the development of the natural resources was characterized by collective learning, improvements in education and transportation and a legal environment where the United States Government allowed entrepreneurs to profit from their discoveries and did not attempt to claim ultimate title to the nation’s minerals. The country encouraged the development of private enterprise and van der Borg (2007) states that the linking and complementary nature of the non-resource sectors of the economy to the private resource sectors have been a vital element contributing to the success of the American economy. Gylfason et al (1999) state as follows: “….the volatility of the primary sector generates real exchange rate uncertainty and may thus reduce investment and learning in the secondary sector and hence also growth.” (Gylfason et al, 1999:204). In the example of the United States as mentioned above, it may be noted that the development of the economy was such that it did not rely upon one primary resource, rather developments in technology were also aggressively undertaken and such advances in technological developments served to set the United States far ahead of other competitors in terms of mineral resources. In Saudi Arabia however, there has been an overwhelming level of reliance upon the primary resource of oil, with 95% of the economy depending upon oil related activities. As a result, other sectors of the economy have been ignored and there has not been much effort to enhance investment in the secondary sector. Moreover, unlike the United States which has privatized the access to mineral resources and allows individual initiative, competitiveness and profit making to fuel and promote a market economy, Saudi Arabia is characterized by a Government riddled with nepotism, where the Government has laid claim to much of the oil producing activity through the ARAMCO Company and also has a harsh legal system in place which is punitive rather than fair and equitable. All of these factors could have contributed to the decline in economic growth, after the initial flush of oil revenues have come into the country. It must also be noted that Saudi Arabia has not made any significant efforts to enhance technological improvements and to explore and develop new avenues and industries that could help to sustain the economy, so that it does not remain primarily dependant upon the fluctuating oil economy. Alternatives to oil are also being developed and the country cannot fail to ignore this development and explore alternative sources of energy as well as the development of other sectors of its economy. However, during the period of the 70s when it was enjoying the oil boom, little if any effort was expended into diversification, industrial diversification or investment in secondary resources and human capital. It appears most likely that this combination of factors could have contributed to the decline of the Saudi Arabian economy. Conclusions: In the light of the above, it may therefore be concluded that economic growth and development is a continuous process that is largely based upon the institutional framework that exists within a particular country. While the availability of a natural resource may serve to initially bring gains to the economy, it is necessary to supplement this with investment in secondary sectors of the economy, and through diversification and restructuring of the industrial framework within the country. As pointed out by Van der Borg (2007) resource rich countries which have good institutions, which encourage free trade and devote a significant part of their resources towards the development in new technology and exploration appear to be able to continue to enjoy sustained economic growth. However, in the case of Saudi Arabia, the sudden oil boom has resulted in a dramatic shift in its economy, which the country was not prepared for, In the aftermath of the oil boom however, the country has suffered a decline due to its failure to utilize the times of affluence in effective planning and growth and development of its infrastructure. The internal framework of the country with its rigid, Islamic rule of law has not been conducive to the development of private enterprise, while the control of the oil industry by the Government and the minority royal family has also significantly deterred private enterprise. The concentration of wealth into the hands of a few has produced the result that the major part of the benefits from oil revenues have not found their way down to the average Saudi Arabian citizen. One of the major reasons for the decline in economic growth in the case of Saudi Arabia appears to be its reliance on the oil industry to the exclusion of others, and a failure to invest in secondary resources such as human capital. However, it must be noted that the Saudi Arabian Government is now taking some steps to reduce its heavy reliance on oil as the prime mover of its economy. It has joined the WTO to improve its trading prospects, which is a good step in the right direction. The Saudi Government is also fostering higher levels of private enterprise in order to promote the forces of the market economy which could help to fuel growth. Moreover, it is also initiating efforts to expand into manufacturing and other areas, which will help to boost its economic growth. As a temporary measure, the steps that are being taken by the Government as a member of the OPEC to secure better world oil prices have helped to boost per capita from 2004 to 2006; however this growth is unlikely to be sustained, especially in view of the fact that there is a concerted effort world over to shift to non oil based alternative sources of fuel, in view of rising oil prices. Therefore, if the country is to ensure that economic growth is sustained, it must develop other sectors of its economy and restructure and diversify into other sectors so that the economy will not rely solely upon oil. The institutional framework of Saudi Arabia may also be in need of reform. It appears likely that the rigid, Islamic framework in countries such as Iran and Kuwait may also be responsible for the declines in economic growth in these countries, including Saudi Arabia. A rule of law that is based upon strict and harsh Islamic codes is unlikely to promote or foster the spirit of private enterprise and place these countries in a position where they can compete effectively in the global marketplace. The system of law a sit currently in Saudi Arabia is punitive rather than progressive and may also need reformation if the country is to progress sin terms of economic development. Through such measures as have been suggested above, it may be possible for Saudi Arabia to continue to sustain the economic growth it has managed to attain during the 2004-6 period. 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(Online[ Retrieved September 27, 2007 from: www.gasandoil.com/goc/news/nta41093.htm * Alum, Klaus, 2002. “The Oil based technology and economy: Prospects for the future” Ekistics, 69 (415-417) : 221 * Easterly, William and Levine, Ross, 2002. “Tropics, Germs and Crops: How endowments influence economic development.” Journal of Monetary Economics, 50(1): 3-39 * “Economics, Business and the Environment: GDP: GDP Per Capita: current U.S. dollars” [online] Retrieved September 27, 2007 from: http://earthtrends.wri.org/text/economics-business/variable-638.html * “Economy of Saudi Arabia” {online] Retrieved September 25, 2007 from: en.wikipedia.org/wiki/Economy_of_Saudi_Arabia * Gylfason, T, 2001. “Natural resources, education and economic development.” European Economic Review, 45, 847-59. * Gylfason, T, Herbertsson, T.T. and Zoega, G, 1999. “A mixed blessing: Natural resources and economic growth.” Macroeconomic dynamics, 3 : 204-225 * Rigobon, Roberto and Rodrik, Dani, 2004. “Rule of Law, Democracy, Openness and Income: Estimating the Interrelationships” NBRE Working Paper 10750. Cambridge: National Bureau of Economic research * Rodrik, Dani, Subramanian, Arvind and Trebbi, Francesco, 2004. “Institutions rule: The primacy of institutions over integration and geography in economic development.” Journal of Economic Growth, 9(2): 131-65 * “Saudi Arabia” [online] Retrieved September 26, 2007 from: http://www.state.gov/g/drl/rls/hrrpt/2003/27937.htm * Van der plog, Frederick, 2007. “Challenges and opportunities for resource rich economies.” European University Institute. [online] Retrieved September 25, 2007 from: http://www.iue.it/Personal/RickvanderPloeg/resource%20curse%20survey.pdf Read More