Diversifying the Saudi economy to secure future growth

The Kingdom of Saudi Arabia has for many years enjoyed prosperity from liquid gold. The price of oil has plummeted in recent years however, and the country’s continued reliance on the resource for its longevity is now in question. In a recent report from McKinsey & Company, the diversification of the economy across a range of areas is considered – with a focus on expanding the private sector by opening up the economy, improving work participation, as well as government efficiency.

The Kingdom of Saudi Arabia has undergone almost a decade of stellar growth following a boom in the price of oil. Since 2003 the country has grown from the 27th largest economy in the world to the 19th in 2014. The country’s nominal GDP of $750 billion outstrips that of Switzerland and Sweden, while its per capita GDP stands at around $24,000, similar to South Korea’s and ahead of that of Portugal. However, the price of oil has since late 2014 fallen by 60%, and as much of the country’s economy is oil funded, this prosperous future is at stake. In a recently released report titled ‘Saudi Arabia Beyond Oil’, the McKinsey Global Institute explores moves the economy could make to maintain its strong growth, as well as the potential long term spinoffs of these moves for the GCC’s least diversified economy.

The increase in income of the country has, for by far the largest part, come from public sector employment; 88% of income growth flowed from Government coffers. These government funds, 90% which is derived from oil revenue, play a considerable role in the increase in worker remuneration. Besides paying workers more, the high oil revenues have seen the Kingdom eliminate its national debt and increase reserve assets to $732 billion, the equivalent of almost 100% of GDP in 2014.

The country has further boosted its public spending on capital projects, pumping around $450 billion into programmes designed to improve education, health, social welfare, infrastructure, and transport. The increase in wealth has seen a further 4.4 million jobs created since 2003, although many have been for foreign workers (2.7 million) that tend to be paid considerably less (between 4-6 times) than Saudi workers.

Demographics
Although the economy has been performing well in terms of its key indicators, and per capita GDP appears relatively high, the overall picture hides considerable disparities in the labour market. Saudi participation rates in the labour force remain low relative to developed or even developing markets, participation of especially female youths (15%) and adults (35%) are well behind that of adult Saudi men (65%). The unemployment rate among women runs at 33%, although government efforts have seen a push for more women onto the labour market.

Foreign workers also see the short end of the stick, tending to be employed for relatively unskilled jobs and paid far less than Saudi nationals. Their average monthly wage of $400 is less than one-third of the average monthly wage for Saudi nationals in the private sector, and one-sixth of the average for Saudi public-sector. According to McKinsey, the consequence from this is that labour productivity is weak, increasing barely 0.8% annually since 2003, compared to 3.3% for the emerging G20 economies.

Economic outlook
As a result of the country’s continued reliance on oil revenue to prop up its finances, the recent drastic drop in oil price to under $40 a barrel has seen the country’s finances enter the red. The Kingdom’s budget has swung from a surplus of 6.5% of GDP in 2013 to deficit of 2.3% in 2014. As the lower 2014 level of oil prices is persisting into 2015, the IMF projects continued fiscal deficits for the Kingdom to 2020, including an estimated deficit of about 22% of GDP in 2015.

Another issue faced by the country’s leadership is providing employment for the bulge of young people that will start to enter the labour market in the coming years. Overall, the population of Saudi nationals is forecasted to expand by six million people, to 27 million, by 2030, a 28% increase over the population in 2014. The number of working age Saudi will increase by 6 million in the coming years. Without increasing the number of jobs available, with the massive decrease in revenues, the ability for workers to support non-workers may well become unsustainable.

According to McKinsey, without policy changes, GDP growth will be limited to 3%, real household income will decrease by 20%, unemployment will skyrocket to 22%, and the country will develop a net deficit of $2 trillion, with an annual deficit of 12%.

Future outlook
McKinsey’s analysis however suggests that it is not all bad news for the country. Key investments that encourage the participation of the private sector in the country may allow the long term outlook to be considerably brighter. The result would see the economy double to 1.6 trillion by 2030 and household incomes up by 60% to $6,000. Unemployment issues would be bridged, dropping to 7%. At the same time national defecate would stay in the black at 2%.

To create the improved financial story for the country, the consulting firm estimates that around $4 trillion in investments will be required. The authors note that, “much of it would come from non-government sources including both Saudi and foreign investors. While the non-oil private sector is relatively small in Saudi Arabia, it has potential to drive much of the growth.” Investment would be required within eight sectors, with a considerable focus on private rather than public sector growth within those sectors, including mining and metals, petrochemicals, manufacturing, retail and wholesale trade, tourism and hospitality, health care, finance, and construction.

To achieve this, the consultancy suggests three key pillars need to be addressed. The first is to increase the level of participation in the workforce of both Saudi men and women, as well as improve the core curriculum. The second pillar is an economic and regulatory environment that is unambiguous, transparent, and conducive to business. This is essential to bringing in the large-scale private investment needed to finance the transformation. The third move is to improve the efficiency of Saudi Arabia’s government, which needs to find new sources of revenue as well as becoming significantly more efficient with spending.