The Saudi Arabian Economy: Policies, Achievements and Challenges

The Saudi Arabian Economy:
Policies, Achievements and Challenges
The Saudi Arabian Economy:
Policies, Achievements and Challenges
M. A. Ramady. Ph.D, FCIB
Library of Congress Cataloging-in-Publication Data
Ramady, M.A. (Mohammed A.)
The Saudi Arabian economy : policies, achievements and challenges / M.A. Ramady.
p. cm.
Includes bibliographical references and index.
ISBN: 0-387-24833-1 elSBN: 0-387-24935-4
ISBN-13: 978-0387-24833-2 eISBN-13: 978-0387-24935-3
1. Saudi Arabia—Economic policy. 2. Saudi Arabia—Economic condition. L Title
HC415.33.R36 2005
330.9538—dc22 2005042507
© 2005 Springer Science+Business Media, Inc.
All rights reserved. This work may not be translated or copied in whole or in part
without the written permission of the publisher (Springer Science+Business
Media, Inc., 233 Spring Street, New York, NY 10013, USA), except for brief
excerpts in connection with reviews or scholarly analysis. Use in connection with
any form of information storage and retrieval, electronic adaptation, computer
software, or by similar or dissimilar methodology now known or hereafter
developed is forbidden.
The use in this publication of trade names, trademarks, service marks and similar
terms, even if they are not identified as such, is not to be taken as an expression of
opinion as to whether or not they are subject to proprietary rights.
Printed in the United States of America.
9876543 2 SPIN 11055693
Dedicated to the memory of my
beloved parents and best teachers
AH and Mahassen Ramady, to my
wife Fatina and to my children
Ali, Faisal and Layla with thanks
for their patience and support
Acknowledgements ix
Abbreviations xiii
1 Overview 1
2 Economic Planning: History, Role and Effectiveness 13
3 Government Finances and the Saudi Budgetary System 41
4 SAMA and Monetary Policy 79
5 The Financial Markets 109
6 The Saudi Capital Market 151
7 The Private Sector : Challenges and Opportunities 185
8 The Kingdom’s Heart: The Hydrocarbon and Minerals Sector 217
9 Foreign Trade 247
10 The Saudi Economic Offset Program 279
via The Saudi Arabian Economy
11. Economic Liberalization: Globalization, 313
Privatization, and Foreign Direct Investment.
12 Population and Demographics: Saudization and the Labor 351
13 Education and Knowledge for Development 387
14 Saudi Arabia and the GCC 417
15 The Challenges Ahead 453
Bibliography 469
Index. 489
This book has been a long time in the making. It draws upon classroom
notes from the course I teach on the Saudi Arabian economy at King Fahd
University of Petroleum and Minerals (KFUPM), as well as on my
experience working in Saudi Arabia and other Gulf countries in banking,
finance and business. Some excellent books exist on the Saudi economy but
the moment seemed right to bring out a current Saudi economy book,
especially given the continuing world-wide interest in the Kingdom.
The characteristics of the Saudi economy have changed beyond
recognition since the heady oil boom days of the early 1980s. This book
attempts to bring the story forward, analyzing challenges and major issues
facing the Kingdom in the modem period. We hope to provide a cohesive
picture of what has taken place over the last three decades, and use it to help
look forward into the new millennium. At the same time, the book
emphasizes aspects of human and social development that have taken place
in past periods, and looks at the accelerated pace of change in today’s Saudi
This helps to identify a unique “Saudi” model and identity on the
economy. In this respect, this book differs from others written on the
Kingdom, which have tended to examine the economy from the more limited
perspective of available data and statistics. They have often neglected to
delve deeper into aspects of Saudi human capital development. Saudi Arabia
is fiilly aware that developing its human capital, both male and female, in
order to achieve self-sustaining growth, is key to a more prosperous fiiture.
The name Saudi Arabia conjures up different images to different people.
These might range from a romantic idealism of the purity of desert life to a
place of unchecked commercialization – with all that implies. The truth, as
ever, lies somewhere in-between. Saudi society is still imbued with the
dignity of traditional desert hospitality, warmth and a noble culture; at the
same time, it is part of a fast-moving, consumer-orientated and impersonal
world. Society will be truly the poorer if the former is eroded in the face of a
relentless march to the latter.
My personal interest in Saudi Arabia goes back to the first “boom and
slowdown” period of 1979-1986, when I worked as Vice President with
Citibank as well as Assistant General Manager with Saudi American Bank
in Jeddah and Riyadh. Some of the material explored in this book, especially
^ The Saudi Arabian Economy
concerning the financial and banking sectors, has been augmented by
personal experiences, and the direction of research was stimulated and
sustained over the past 25 years by a continued interest in the welfare of the
people of Saudi Arabia.
The Kingdom, despite its fluctuating fortunes, still attracts an enormous
amount of interest worldwide. The Riyadh bombings of May, 2003, and the
domestic terrorism that followed propelled Saudi Arabia and its citizens into
the limelight – reluctantly and for the wrong reasons. This forced an
accelerated internal debate on economic and social reforms that had started
prior to these events. This book will attempt to explain how the desert
Kingdom’s economic systems are opening up and evolving, faster than some
would want, slower than others hope for, but evolving and changing, they
are Saudi Arabia today is beginning to reflect some of the problems and
strains of other developed nations, both in terms of structural adjustments of
the economy and of meeting the aspirations of its largely young population.
How it handles such issues will be of interest to others facing the same
dilemmas, especially those in the Arab world, as well as to the wider
international community of nations wishing to see the Arab region make
economic, political and social progress.
The Kingdom has left an indelible mark on millions of expatriate
workers as well as others who have passed through the country. It has been a
good experience for the overwhelming majority. For those who were
positively challenged, Saudi Arabia has provided an unique opportunity to
assume greater responsibilities, manage mega-scale projects, make
substantial financial savings, take bold initiatives, and, in so doing, enrich
their professional lives. Few other countries could have afforded them such
an encounter. For those experiences, especially the chance to contribute to
the development of the current Saudi banking structure, I am grateful.
Any book benefits from the influence and support that others give to its
author to help bring it into the public arena.
My grateful thanks go to my colleagues at KFUPM, including Their
Excellencies the present and previous Rectors, Drs. Khaled Al Sultan and
Abdulaziz Al Dukhhayil, for encouraging me on this book-writing project,
and to Professors Mohamed Budair, Abdulaziz Al Swaiyan, Aref Al Ashban,
Ibrahim Al Gahtani, Sulaiman Al Sakran, Mohammed Al Sahlawi, Musa
Essayad, Zohair Yamani, Usamah Uthman, Mohammed Al O’Hali,
Mobarak Al Ghamdi, Abraham Abraham, Fazal Sayyed, Mohsen Al Hijji,
Yakubu Umar, Bassam Hamdan, Abdelwahab Al Gahtani, Khaled Al Zamil,
and Mohammed Al Homoud. I appreciate their willingness to discuss issues
affecting the Saudi economy and society at large and to be a valuable
sounding board for ideas, even when we disagreed.
Acknowledte merits xi
My thanks also go to my many KFUPM undergraduate and postgraduate
students of the Econ 306, Econ 305, MBA 501, and Executive MBA 561
classes, for encouraging me on this path and for sharing their thoughts on the
aspirations of Saudi youth. In particular, the following students are to be
commended for their perceptive class contributions: Mohammed Al Saleh,
Nayef Saleh Al Hamdan, Yasser Al Jeraisy, Fahd Khaled Al Saud, Wael Al
Gudaihi, Emad Nashar, Ali Al Gafeli, Yousef Al Humaid, Ibrahim Al
Nuaim, Mishari Al Assaf, Mohammed Al Aiban, Bader Al Bassam,
Mohamed Al Yemni, Bader Al Rajhi, Majed Al Anqari, Ahmad and Akram
Sab, Fahad Al Tuwaijri, Turki Al Jammaz, Turki Abdulrahman Al Saud,
Ahmad Dawood, Faisal Al Al Sheikh, Mishal Al Huwaish, Alaa Dahlawi,
Bader Al Nowaiser, Fawaz Al Jomaih, Sultan Al Sultan, Mohamed Al
Bawardi, Saad Al Kroud,Fahd Sulaim Al Zamil, Khaled Bin Abdelrahman
Al Faisal Al Saud, Khaled Rubaian, Fawaz Al Tuwaijri, Abdullah Al
Ghamdi ,Omar Sulaiman and Mohamed Bin Turki Al Saud. Students such as
these inspire confidence in the ability of the Kingdom to meet the challenges
of the fixture.
Over the years I have benefited from various practitioners and experts
about the Kingdom and the region in general, and my appreciation is due to
Kevin Muehring, John Milne, Michael Field, Sass Ghassanpour, Noel
Brehony, Ed 0’Sullivan, Guy Gantley, L F T (Tim) Smith, Richard Keck,
John Botts, Richard Murphy, Gavin Shreeve, and to many others – too
numerous to mention – for their genuine concern about the region, their
insightfiil comments and their sharp wit.
A special word of thanks goes to the Dean of Library Affairs, and to his
tireless staff, for meeting my many reference requests. Last, but by no means
least, thanks are due to the dedicated efforts of the secretarial and technical
staff, Junaid Akhtar and Totty Raborar, and to Sue Katz for the editing. Any
shortcomings in the book are entirely my responsibility.
Finally, I would like to acknowledge the financial support provided by
KFUPM under Project No. IM/SAUDI ECONOMY/281.
Dr. MA. Ramady, FCIB
Department of Finance and Economics
King Fahd University of Petroleum and Minerals,
ACH Automated Clearing House
AMF Arab Monetary Fund
Bear market falling market prices
BIS Bank for International Settlement, Basle, Switzerland
BOO Build Operate Own
BOT Build Operate Transfer
BOOT Build Operate Own Transfer
Bull market Rising market prices
CDS Central Department of Statistics
ceteris paribus Assuming everything else is equal
CPO Central Planning Organization
CRR Cash Reserve Ratio
CSCCI Council of Saudi Chambers of Commerce and Industry
Downstream processing of gas and oil for final product delivery
Emir Ruler
EPCCI Eastern Province Chamber of Commerce and Industry
ESIS Electronic Share Information System
EU European Union
FATF Financial Action Task Force
Fed (The) Federal Reserve Bank, USA
FRN’s Floating Rate Notes
GAFTA Greater Arab Free Trade Area
GCC Gulf Co-operation Council
GDB’ s Government Development Bonds
GDP Gross Domestic Product
GFCF Gross Fixed Capital Formation
GNP Gross National Product
GOSI General Organization for Social Insurance
Hajj Annual Muslim Pilgrimage to Makkah
Hallal permissible in Islam
Haram forbidden in Islam
IDB Islamic Development Bank
XIV The Saudi Arabian Economy
Majls Al-Shoura
Reverse Repo
International Monetary Fund
International Oil Companies
Initial Public Offering
Saudi residence permit for foreigners
Jeddah Interbank Offer Rate
King Abdulaziz University
Saudi sponsor of foreign labour
King Faisal University
King Fahd University of Petroleum and Minerals
Kingdom of Saudi Arabia
King Saud University
London Interbank Offer Rate
Saudi Mining Company
National Consultative Assembly or Council
million barrels per day
Middle East and North Africa
One million British thermal units
Ministry of Finance
Ministry of Planning
National Commercial Bank
National Company for Cooperative Insurance
Normal Effective Exchange Rate
Natural Gas Liquids (or sometimes NLG)
Offshore Banking Unit
Organization for Economic Cooperation and Development
Organization of Islamic Conference
Organization of Petroleum Exporting Countries
Official Repurchase Rate
Public Investment Fund
Research and Development
Muslim month of fasting
Real Estate Development Fund
Real Effective Exchange Rate
Repurchase Agreement
Reverse Repurchase Agreement
usury interest
Reverse Repurchase Rate
Status quo
Takaful Ta’awni
Saudi Arabian Agricultural Bank
Saudi Arabian Basic Industries
Saudi Arabia General Investment Authority
Saudi Arabian Monetary Agency
Saudi American Bank (until October 2004)
Saudi Riyal Interbank Express System
Saudi Arabian Airlines
Saudi Credit Bank
Saudi Chambers of Commerce and Industry
Special Drawing Right
Security and Exchange Commission
Saudi Export Program
Saudi Fund for Development
Islamic Law
Saudi Interbank Offer Rate
Saudi Industrial Development Fund
Saudi Credit Bureau
Saudi Individual Stock Traders
Statutory Liquidity Ration
Small and Medium Sized Enterprises
Saudi Payment Network
Saudi Pension and Retirement Agency
Saudi Riyal
Keeping things unchanged
Saudi Telecom Company
Sayings of the Prophet Muhammad (pbuh)
Electronic share trading and information system
Islamic cooperative life insurance product
Tadawul All Share Index
Treasury Bills
Trillion Cubic Feet (of gas)
production of oil and gas from wells
Saudi commercial agent of foreign companies
connection, favour
World Trade Organization
Chapter 1
We judge ourselves by what we feel capable of doing, while
others judge us by what we have already done.
Saudi Arabia has changed dramatically over the past three decades –
economically, socially and demographically. This would be a short period in
the lifespan of many nations; but for the Kingdom, it has been a long time.
This book examines the key factors leading to the fundamental changes
that are shaping the future destiny of the Kingdom, often in directions that
cannot be predicted with certainty. However, some indicators are emerging
in the Saudi economy that point towards possible outcomes and potential
There are several distinct but overlapping themes in this book. Readers
can focus on chapters with common themes or one can use this book to teach
a course that blends theory and current policy issues. The choices are yours.
Whichever option is followed, it will become apparent that certain
overriding issues prevail in all chapters and themes. The key issues relate to
diversifying the economy, managing expectations based on a narrow revenue
base, coping with the needs of a young and growing population, empowering
the private sector to become the engine of growth through job creation and
exports and, finally, ensuring this sector’s willing cooperation in the process
of Saudization through replacing foreign workers with Saudis.
The country also has to deal with the consequences of its imminent
World Trade Organization (WTO) entry and the challenges and
opportunities of globalization. The Kingdom must set up the necessary
2 772^ Saudi Arabian Economy
regulatory frameworks for an expanded financial and capital market, as well
as overseeing the switch from a public sector-driven delivery base to one
dominated by the private sector, in line with plans to privatize government
This hurdle of simultaneous challenges would be a tall order for any
nation to handle. For Saudi Arabia, it also includes reforming the educational
system to be in line with market needs and with a knowledge-based
economy. The country also seeks to meet the aspirations of its female
population through expansion of their participation in the economy and
society at large, but without compromising on basic religious beliefs,
customs, and traditions.
Setting the stage
The first broad themes are covered in Chapters One and Two. Chapter
One addresses how economic planning was introduced and implemented in
Saudi Arabia, and examines its evolution and whether it had managed to
lay the framework for meeting future challenges. The chapter examines the
strategic economic decisions Saudi Arabia made in the early boom era, the
consequences of which are still apparent today. These consequences include
investment in capital-intensive infrastructure and basic industries, reliance
on cheap energy input, the use of subsidies and incentives to promote
economic growth and the import of large numbers of foreign workers.
Planning during this period evolved from being directive to indicative, as the
economy expanded and opened up to international trade. It also focused
more on the private sector and started to set qualitative indicators, rather than
the quantitative indicators of earlier planning periods. Chapter One points to
Saudi Arabia’s need for a more strategic and flexible short-term planning
process that is better suited to a faster-evolving global economy.
Chapter Two assesses the Saudi budgetary framework and the urgent
long-term need for a wider revenue base diversification. This will help the
Kingdom move away from an inherent fiscal deficit situation and ballooning
internal debt – currently standing at around 90% of GDP although the
government has signalled its strong intent to reduce this debt in the
2004/2005 budget. The chapter also discusses the possible crowding out of
the private sector, which the government hopes will assume the future
capital project funding needs of the Kingdom, estimated at around $400
billion over the next twenty years. It then examines the centrality of oil
revenue and the lack of government control over nearly 90% of its revenue
sources, pointing towards the need to adopt a new strategy to meet future
fluctuating oil fortunes in order to move away from being a hostage to a
petrolized economy.
The financial sector
We explore our second major theme in Chapters Four, Five and Six, as
we examine the evolving, and, in some respects, mature financial sector of
Saudi Arabia. Chapter Four also analyzes the evolution of the Saudi de facto
Central Bank – the Saudi Arabian Monetary Agency (SAMA). It looks at
how SAMA has assumed a wide range of responsibilities and supervisory
regulatory powers despite being constrained in the use of more traditional
central bank policy tools, such as discount and interest rate instruments.
However, SAMA has effectively managed the other range of monetary and
exchange rate policy tools available to it, as well as ensuring that today the
Saudi banking system is one of the most capitalized, liquid and profitable in
the world. At the same time, SAMA has supervised the smooth transition of
the Kingdom’s foreign bank presence to joint partnerships, that is, a
Saudized banking framework. This has turned out to be an effective
partnership tool for transferring technology and management skills to the
Saudi financial sector. Chapter Four explores the growing sophistication of
the SAMA’s use of repos and reverse repos as proxy monetary instruments,
as well as SAMA’s management of the national debt. It also considers the
rationale of SAMA’s fixed exchange rate policy for the Saudi Riyal and the
Kingdom’s money supply creation process.
Chapter Five further develops this theme and examines the broader
financial markets that have evolved in the Kingdom, especially in the
commercial banking sector. This sector is comprised of a mix of whollyowned “pure” Saudi banks, joint-venture Saudi-ized banks, the newlyapproved foreign banks and other financial sector players, such as the money
exchangers and the specialized government financial institutions. The latter
played a crucial role in providing long-term concessionary credit for Saudi
economic development when most commercial financial institutions
preferred to take short-term risks. Chapter Five examines the core strength
and market strategies of these various financial institutions and their
financial performance. The emerging insurance sector is also discussed, as
well as the growing role of Islamic financing in Saudi Arabia and how the
Kingdom’s financial sector hopes to cope with globalization threats and
The focus on the financial sector concludes with Chapter Six, which
analyzes the Saudi Capital Market through a discussion of the evolution of
the domestic capital markets, the operating regulatory framework and
various obstacles. This is followed by an assessment of the new Capital
4 The Saudi Arabian Economy
Market Law and future prospects for the capital market. We explore the
issues of ownership concentration and of the lack of depth of the Saudi
Capital market, in contrast to the Kingdom’s dominance of the Arab stock
markets, in terms of size and performance. This chapter analyzes the sectoral
composition of the Saudi stock market and the inherent weaknesses of
having a thin market base. We assess investor behaviour, and take an indepth look at the Saudi mutual fund market, the largest and most diverse in
the Arab world. The Saudi government debt market’s structure is closely
examined, as well as the future evolution of the Saudi Capital Markets in the
face of ongoing liberalization and privatization. We provide some estimates
for new company listings on the Saudi capital markets; these estimates
indicate that an additional entry of 137 new companies would almost double
current market capitalization, to take it to around the SR 890 billion levels.
The heart of the Kingdom: The hydrocarbon sector
The third theme of the book revolves around both the private sector and
the challenges it faces, and Saudi Arabia’s hydrocarbon and mineral sector –
truly the heart of the Kingdom’s revenue generation, diversification
prospects and value-added job generation.
Chapter Seven critically examines the challenges for the Saudi private
sector as it shoulders the responsibility of transforming the Saudi economy
into a market-driven generator of wealth. It is important to assess whether an
appropriate business environment exists in the Kingdom today, one that
enables the private sector to take up these challenges. Therefore, we examine
the legal, corporate and economic environments under which the private
sector has to operate. We look, too, at the issue of foreign labour
participation and current Saudi government pressure on the private sector to
accelerate the process of Saudization. The role of the small- and mediumsized enterprises (SMEs) is examined, as well as the obstacles they face and
how the government is trying to overcome these obstacles (given the
importance of the SMEs to Saudi Arabia’s goal of job generation and
regional economic diversification). Chapter Seven also explores the role of
the Saudi family businesses and their structures, and advocates for some
changes to family businesses to enable them to meet the fiiture challenges of
globalization and the situation after Saudi entry to the WTO.
This chapter also considers Saudi women and their growing importance
in the national economy; we note the obstacles currently faced by women in
managing their own businesses, and investigate how they are overcoming
these barriers. During 2004 there has been a greater momentum to generate
more female job opportunities, to increase women’s participation in
economic nation-building and to open up more sectors for them.
Overview 5
The chapter further explores the development over time of the complex
and evolving business relationship between the Saudi government and the
private sector. We look at the government’s role as planner, as financing
entity, as buyer and seller, as regulator and as revenue collector. The issue of
Saudization and how the private sector views it is examined in some detail,
showing that the private sector and the government have divergent views.
The private sector argues that Saudization can only succeed when a supply
of skilled labour exists that meets market needs at competitive wage levels,
and that the government needs to embark on a more aggressive control
mechanism of foreign labour supply to the private sector in order to force
Saudi employment.
Chapter Eight discusses the oil and gas sectors and explores the
opportunities that lay in the as-yet-relatively untapped non-carbon minerals
sector. The importance of oil, its dominant effect on the Saudi economy and
the Kingdom’s pivotal role in this energy sector is highlighted. This chapter
also thoroughly examines Saudi oil policy and its constraints. The record oil
prices experienced during 2004, with oil prices exceeding $50 per barrel on
fears of supply shortages, underscored the Kingdom’s importance as the
major excess capacity producer of the world. Saudi gas, a new and important
energy sector, is appraised in light of Saudi Arabia’s attempts to attract
foreign investment and technical partners to this field. Besides having a
quarter of the world’s proven oil reserves, Saudi Arabia also has the world’s
fourth largest gas reserves and is the world’s largest natural gas liquid
(NGL) exporter.
Chapter Eight also looks at the Saudi petrochemical industry, particularly
as it could be the major beneficiary of WTO entry. Today the Saudi Arabian
Basic Industry (SABIC) is a significant player in the world’s petrochemical
markets, planning expanded operations both at home and abroad. For some
products, SABIC’s world share stands at around 18-20%, and it is a credit to
the Kingdom that this was achieved in fewer than twenty years’ time,
literally created out of the desert. Chapter Eight carries on exploring the
Kingdom’s mining sector and its potential to diversify the economic base
and generate an integrated mining industry. If developed, the Kingdom’s
extensive mining resources could rank Saudi Arabia amongst one of the
leading mining countries of the world.
The planned privatization of the Saudi Mining Company (Maaden) will
involve the restructure of the company into separate units of gold, phosphate,
bauxite, aluminium and other minerals. Foreign investors in the mining field
will be encouraged to explore under planned new mining law concessions.
Chapter Eight presents a new model of mining cooperation with foreign
companies that will assist in taking privatization forward. This model could
help shield the Kingdom from fluctuations in basic commodity prices, such
6 The Saudi Arabian Economy
as oil, resulting in a narrow revenue base, despite the record 21-year high oil
prices seen during 2004.
Foreign trade and technology transfer
Chapters Nine and Ten deal with the next theme, Saudi Arabia’s foreign
trade, along with the issue of technology transfer through the use of
economic “offset programmes” used to enhance the economy’s base and
generate new high technology enterprises.
Saudi Arabia has embraced an open, market-based economy with few
restrictions on goods and service, except for those that are in direct conflict
with religious beliefs (including the import and consumption of alcohol and
pork-related products). This liberal market policy is reflected in the
Kingdom’s trade relations with the rest of the world. Imports come today
from virtually all continents, while Saudi exports flow to all major
industrialized and developing countries. Saudi Arabia’s major trading
partners continue to be the United States, the European Union and the Far
East; China is viewed as the major trading partner of the fiiture.
Exports from the Kingdom follow the same import trading patterns, and
some effort has recently been made to ensure that Saudi exports become
more diversified. Currently some 90% of total exports are made up of oil and
energy-related petrochemical products. It is this narrow export base that is
worrying those who see potential problems for Saudi non-oil exporters postWTO entry for the Kingdom. While Saudi Arabia has run relatively
consistent trade surpluses, the Kingdom suffers from capital outflows due to
large remittances by foreign workers, averaging around SR 60 billion per
annum, as well as private sector private capital outflows. Since 2002, Saudi
banks have reported some capital repatriation to the Kingdom due to a rising
Saudi stock market and a booming real estate sector, in addition to Initial
Public Offerings (IPO) and privatization opportunities.
Analysis of Saudi Arabia’s trade patterns reveals a shift in the type of
products imported over the past three decades: during the earlier boom
period, the imports were of capital goods, construction and machinery. Later
these imports gave way to spare parts, food and consumer goods. Inter-Gulf
Cooperation Council (GCC) trade still plays a small part. Saudi Arabia is a
net GCC importer, especially from Dubai and Bahrain which re-export to the
larger Saudi market.
The transfer of appropriate technology to the Kingdom has always been
of major importance, either through Foreign Direct Investment (FDI), joint
ventures or through the Saudi Economic Offset Program. Chapter Ten
examines the rationale behind the offset programme. When it was initiated in
the mid-1980s, it was the first of its kind in the Middle East. Saudi Arabia
Overview 7
sought to obtain benefits from foreign contractors through transferring
technology and training local labour. Our analysis reveals mixed success for
the current offset programmes, especially in terms of employment generated,
but notes that offset companies in general did transfer higher levels of
“technology packaging” than did non-offset private sector joint venture
companies. Chapter Ten highlights the need for continued reforms of
educational institutions in order to produce Saudis with the necessary
scientific and technological skills to benefit from such offset ventures. There
is also a need to develop a culture of research and development within the
private sector.
Meeting future challenges
The final theme involves analyzing some key challenges faced today by
the Saudi economy as it goes through painful structural adjustments. These
challenges overlap, as they often do, since economic transformation do not
occur in compartmentalized isolation, but rather react to one another in a
dynamic fashion.
The challenge to the Kingdom’s policy makers is to try and identify key
positive drivers operating in the economy that will lead the country forward
to set objectives while minimizing the negative consequences to society at
Under this broad theme. Chapter Eleven examines the Kingdom’s hopes
and aspirations for Foreign Direct Investment the strategic option for
liberalization and privatization, and looks at the potential benefits and costs
of globalization and WTO entry. This chapter illustrates that Saudi Arabia’s
problem is not a lack of good intentions or of proper priorities, but rather that
there is no matching consensus as to how much action is needed, and how
quickly the Kingdom should act. Some tangible progress has been made
through the establishment of the Supreme Economic Council, which has
focused on developing the regulatory environment that will allow a
successful privatization programme to emerge. Another positive
development involves the enhancements of the Foreign Investment Law that
offer a number of benefits, including a recent reduction in taxation levels to
20% on foreign companies’ profits.
It is the globalization issue that remains unresolved to date. Saudi
Arabia’s entry to the WTO is only a matter of time, and the Kingdom is
using the period before entry to liberalize certain key sectors, especially in
finance and insurance, as well as enforcing intellectual property rights.
Chapter Eleven closely examines the impact of globalization on Saudi
Arabia’s financial structure. While it seems clear that this sector of the
8 The Saudi Arabian Economy
economy will withstand any negative globalization issues, the rest of the
private sector needs to adjust more rapidly, especially in terms of company
structure and internal efficiencies.
The critical issues of the moment – employment, Saudization and the
structure and composition of the Saudi labour market – are dealt with in
Chapter Twelve. With nationals accounting for just under 11.5% of the total
private sector labour force, or around 640,000 Saudis, the government is
making copious attempts to ensure that more jobs are found for nationals,
either through creating new jobs or replacing foreigners through an
invigorated Saudization program.
The government, however, can only push so hard. In the final analysis,
Saudis with the appropriate market-driven skills will be employed. Others
seeking jobs will realize that is necessary to change their mind-set and to
accept positions previously deemed to be either too menial or socially
unacceptable. This might be a prime reason why, according to press reports,
some 150,000 Saudis failed to complete job application formalities for
guaranteed jobs identified through regional employment offices over the past
four years.
The mindset is changing, and some sections of Saudi youth are beginning
to be more realistic in their job expectations as they compete with other new
labour entrants, a result of one of the world’s highest population growth
Windfall gains arising from one or two years of higher than expected oil
revenues, such as those experienced during 2003 and 2004, might produce a
short-term “feel good” factor, but cannot solve such long-term demographic
realities. This chapter also looks at the issue of female labour participation,
since the Kingdom has one of the lowest female labour participation rates in
the world. Even within the Middle East, Saudi’s rate is about 6% compared
with a 17% average for the rest of the Middle East.
Saudi female participation tends to be higher for those in the older age
group, forcing younger Saudi women to prolong their entry to the labour
market either by pursuing higher education or seeking less qualified jobs.
Once again, the Saudi government recognizes these problems and the Saudi
Cabinet recently approved a nine-point plan to create more jobs and business
opportunities for women, including the restriction of expatriate jobs in areas
dealing with women-only services.
In any society, unemployment is not only a cause of social problems and
of increased unemployment-related crimes, but also of potential loss to
national output and productivity. Chapter Twelve calculates the cost of such
a potential Saudi output gap. Using Okun’s Law, this was estimated at
around SR 327 billion for the period 1993-2002, based on fairly high levels
of voluntary (or “natural”) rate of unemployment for Saudi society. If this
Overview 9
natural rate of unemployment were much reduced, then both the output gap
and real rate of unemployment would be much higher using Okun ‘s Law
than those estimated in Chapter Twelve.
Our analysis of earlier themes clearly marks the important role that
quality education and the acquisition of market-related skills play in shaping
Saudi economic development.
This issue is examined more closely in Chapter Thirteen, which analyses
the current Saudi educational structure’s achievements and problems.
Technological progress and the diffusion of scientific and technical
innovations lead to higher productivity and improvement in all sectors of the
economy. The ability of any society to produce, select, adapt and
commercialize knowledge is critical for sustained economic growth and
improved living standards. In relation to its population, size and undoubted
quantitative educational investment, Saudi Arabia has produced negligible
commercial patents compared with other developing countries such as
Malaysia or Singapore.
Quality education output is now a key priority for the Saudi government.
The 2004 budget allocation for education showed that the Saudi government
is beginning to direct resources towards higher education and vocational
training institutions that are graduating students who meet labour market
needs. During the 2004 academic year, the government directed Saudi
universities to curtail enrolment in some non-job or market-related subjects.
Once again, one must put Saudi Arabia’s phenomenal transformation
into perspective to assess how far the country has travelled in a short period
of time. For the whole period of 1927-1960, the country boasted only seven
Ph.D graduates from foreign universities. In 2001-2002 alone, there were
185 Saudi Ph.D graduates from foreign universities, of which 22 were
women. The total number of Ph.D graduates from Saudi universities was
154, of which 82 were women. It is a proud achievement for any country,
but especially for Saudi Arabia where debate in the late 1950s concerned
whether to allow female education at all
Despite massive investment in education over the past three decades,
Saudi Arabia’s real per capita income has fallen considerably from around
SR 62,000 in 1981 to SR 32,000 levels in 2002/2003. The population has
grown faster than its oil revenues, and labour productivity has not kept pace
with private sector market forces. In order to compensate for this oil drag,
both labour productivity and educational standards will have to rise
significantly faster in the next decade.
The Kingdom is not an isolated island. Regional developments, whether
positive or negative, have profound consequences on internal stability, and
on economic and social developments. Chapter Fourteen explores Saudi
Arabia’s multi-faceted relationship with the other five members of the Gulf
10 The Saudi Arabian Economy
Cooperation Council (GCC), as developments within the GCC could have
far-reaching economic consequences for the member states. This chapter
examines why the GCC union was established in 1981 and discusses its
developments to date.
Chapter Fourteen aims to impart an understanding of the internal
economic dynamics of the various GCC member states and of how far
similarities and differences could accelerate or impede planned full monetary
and customs union by 2010. Economic diversification, generating
employment for their young and growing populations, and economic
integration is the destiny of the GCC countries. Oil is central to their wellbeing. Between them, the six GCC countries sit on some 45% of the world’s
total oil reserves, illustrating the magnitude of the region’s importance.
Chapter Fourteen shows that some success has been achieved, albeit on a
modest scale, in the effort of individual GCC member states to diversify
away from a narrow oil and gas revenue base. Dubai and Bahrain are leading
the way.
Saudi Arabia’s economy, size and market potential continue to dwarf all
the other GCC countries. The Kingdom has sometimes pursued policies for
the greater good of all other member states rather than for narrow selfinterest. The next test of leadership will be GCC’s management of the
transition towards full monetary union and a single currency by 2010, which
requires a greater degree of fiscal and monetary policy harmonization than
Integration of various capital markets could be a first step in mobilizing
domestic financial resources into large, economically-viable inter-GCC or
national projects. Integration would also help facilitate a greater degree of
inter-GCC job seeker migration and ease unemployment problems faced by
some GCC countries while filling the job openings of other member states.
In the long term, it is important to ensure that the GCC becomes open and
accessible to its ordinary citizens so that they understand the objectives of
the GCC, why it was established and how it affects their lives. It is only by
doing this that the viability of the GCC’s long-term future can be guaranteed,
and that the “GCC family” survival as a stronger political and economic
entity in the 21st century can be ensured.
Following these broad themes. Chapter Fifteen concludes by reviewing
some key structural issues affecting the Saudi economy and highlighting
some of the problems that need to be addressed going forward. There is a
new sense of realism in the Kingdom amongst policy markers, the private
sector and the population at large. Despite domestic terrorism issues, there is
Overview 11
a mood of detemiination to tackle pressing problems. Reforms and domestic
changes are important, but they must not be seen as a competition between
external and internal domestic reform agendas. Both need to progress at a
comparable pace, without external pressure. Managing both expectations and
the pace of reform will be a key challenge as things progress, as will be the
management of the Saudization process and the maintenance of harmonious
relations with expatriate labour.
Reforms, although implemented gradually, can be cumulative in effect.
Gradual change may seem slow or less impressive to those outside the
Kingdom, but if reforms are to endure and be effective, they have to respond
to the needs, customs and mores of all society if they are to succeed. Far too
many experts have misjudged and underestimated the resilience of Saudi
Arabia, or the adaptability and creativity of Saudi society in meeting future
challenges. Consensual change will be the means of change. The key will be
a process of evolution and consensus building, the hallmark of Saudi
government, thus allowing for longer term economic planning and stability.
Chapter 2
The foundation of every state is the education of its youth.
Learning outcomes
By the end of this section, you should understand:
The need for planning
The strategic choices faced
Trends in planning expenditures
Evolution of the Saudi economy
Planning and “engines of growth ”
Gazing into the future
Domestic challenges of change amid transformation are not particular to
the oil-producing nations of the Gulf. Neither is the concept of planning new in
substance, although the degree of emphasis and the direction can be new.
Saudi Arabia is today facing challenges more pressing than at any other time in
its recent history; these range from demographic structures to structural
economic imbalances, from the absence of key economic drivers for growth
and employment to the critical importance of the role of the private sector as
the “engine of growth.”
According to observers, Saudi Arabia has some of the most sophisticated
development planning processes of any nation in the developing world
(Cordesman, 2003). However, good intentions and good plans do not, on their
14 The Saudi Arabian Economy
own, ensure implementation. As will be discussed, Saudi leaders have indeed
set what seemed to be the right priorities for the nation, but sometimes events,
both domestic and international, have overtaken their planning exercise,
throwing good intentions off-balance. It takes foresight and determination to
switch directions and persevere to bring about changes over time.
Why the need to plan?
It is often said that “the best government is the most invisible government.”
This means that “best” governments are those that establish regulatory and
legal frameworks and then allow the competitive pressure of free market forces
to determine the optimum allocation of resources needed by society. There are
those who would argue that this is a Utopian luxury that governments in the
modem world aspire to, but few achieve in reality. The real world has
witnessed a degree of planning and government control, ranging from central
planning to what is termed mixed economies, where the government and
private sector work together in partnership. Irrespective of which model of
planning is adopted, the central goal seems to be the laying of a broad
economic foundation for self-sustaining growth with one or more key factors
of production (land, labour, capital or managerial efficiency) creating the
precondition for self-sustained growth (Rostow, 1960).
Saudi Arabia’s economic development path has sometimes been
characterized as one of a classical “rentier” economy (Chaudhry, 1989, 1997,
Auty, 2001). In this model, the government seeks to maximize its revenue
from a natural resource – oil – and distribute the proceeds amongst various
sections of the population. Some distinguish between a “rentier” economy and
a re-distributive “welfare state” that derives its income through taxation and
other means from one class of society and distributes it to other sections of
society (Chaudhry, 1989).
Since Saudi Arabia currently does not impose taxes on its citizens, the term
“welfare state” is not technically correct for the Kingdom. The concept of
“rentier economy” is a more accurate characterization of the early years of
Saudi Arabia’s economic development. According to some observers, an
alliance developed between the State and certain business groups in the private
sector that aimed to promote the national agenda at the expense of some
excluded groups (Wilson, 2004, Champion, 2003).
During the early boom period of the Saudi economy in the 1970s and early
1980s, the large inflows of oil “rents” to the State created a momentum of its
own, in which it seemed that the State’s only fiinction was that of a distributive
agent and that the government sector became the exclusive motor of the
economy (Chaudhry, 1977). The lack of administrative, educational,
managerial and physical infrastructure led to absorbative capacity bottlenecks
Economic Planning: History, Role and Effectiveness 15
in those early boom days, with investment decisions being taken that had farreaching consequences for the future (Mallakh, 1982).
The basic argument against “rentier economies” is that when a state’s main
source of private revenues is through government expenditures, the society
thus supported does not instil a sense of initiative or entrepreneurship amongst
its citizens. However, a state that is supported by society through one form of
taxation or another will develop a more balanced relationship with its citizens,
with both parties responding to the needs of the other (Ehteshami, 2003).
One further effect of the “rentier economy” was the emergence of powerful
state bureaucracies which “orchestrated the States’ development” (Ehteshami,
2003). The effect was to perpetuate the preference for government jobs in
Saudi Arabia, which we shall examine in later chapters, at the expense of the
private sector, since bureaucracy viewed the private sector in a subservient
relationship instead of as a dominant force. This relationship between the
government and private sector affected the “institutional capacity to deliver”
(Wilson, 2004). Surveys of attitudes of senior civil servants carried out in
Saudi Arabia in the early 1980s showed deficiencies in “psychological drive,
flexibility, communication, client relations and impartiality” (Hegelan and
Palmer, 1999). According to some observers, there is little evidence that much
has changed since those early days (Wilson, 2004).
The above arguments and counter-arguments are easy to discuss in
hindsight. The reality of the matter is that Saudi Arabia opted for an operating
planning framework to guide the national economy long before higher oil
prices propelled Saudi Arabia to the forefront of world economic headlines in
1973/1974. The First Plan covered the period 1970 – 1974. By the time the
First Plan period had ended, the Saudi economy was fundamentally
transformed, as will become evident later in this chapter when we analyze the
structure of the national economy.
Strategic choices
In the early 1970s, the Saudi government along with its key planners and
consultants grappled with strategic decisions on the direction the economy
should be steered. It was not an easy task, given the lack of planning
experience, absence of data on the economy and raised expectations of Saudi
nationals. Table 2.1 examines some of the strategic development options that
were faced by Saudi planners and their potential positive and negative
Each of the options set out in Table 2.1 has appealing positive factors, and
these positive factors would have been paramount in the planning discussions
– rather than the negative consequences. The country was in a rush to develop
rapidly. There were few lengthy discussions or in-depth analysis of potential
16 The Saudi Arabian Economy
negative consequences of one strategic development objective or another
(Farsy, 1982), although some commentators did raise early concerns (Bashir,
Table 2.1 Saudi Arabia: economic development options
Development option Positive Factors Negative Factors
Large oil production Large foreign investments
and surplus financial
Balance of payment
No incentive to fund crude
oil substitutes
Economic dependency
International and domestic
Rapid consumption of nonrenew^able national
Rentier economy
Oil production based on
domestic needs
• Moderate investments
abroad leading to paced
development and
equilibrium betv^een
domestic development
needs and financial
• Large oil reserves for
future generations
World oil shortages
High international inflation
and world recession
Strong incentive to find
crude oil substitute and
Large scale domestic
industrialization and
diversification of economic
Potential economic
Skills acquisition and new
working habits.
Exports potential
Technology transfer
Education base widened
Non-oil economic
• Large imports
• Need for expatriate labour
• Balance of payments
problems with a large
element of exported
salaries and profits
• Domestic inflation
• Institutionalized
inefficiency due to subsidy
policy (import substitution
• Mismatch between
domestic labour supply
output and market
From all indications, what has actually transpired from the early 1970s to
date is that Saudi Arabia opted for large-scale domestic industrialization and
for diversification of the national economic base. The aim was to “transform
the economy from overwhelming dependence on the export of crude oil into a
diversified industrial economy”, while admitting that dependence on oil
revenues will continue for a considerable period of time (Farsy, 1982).
Economic Planning: History, Role and Effectiveness ] 7
Depending on substantial cmde oil production alone was not a long-term
strategic choice, for it would have magnified the negative consequences of the
“rentier economy” system discussed earlier. It would have meant a more rapid
consumption of Saudi Arabia’s non-renewable natural resource; the only key
decision facing the country would simply have been the rate of oil extraction
and the price of oil.
Production of oil based merely on Saudi Arabia’s domestic needs would
have produced oil shortages, international inflation and world recession, along
with a strong incentive to find other suppliers as well as crude oil substitutes.
As we will explain in later chapters, Saudi Arabia is cognizant of its key role
in world oil supply and has pursued moderating policies in its attempt to ease
oil supply shortages. The most recent example was the Kingdom’s decision in
September, 2004, to increase its production from 8.3 million barrels to over 11
million barrels per day – virtually its full capacity – in order to ease soaring
prices of over $50 dollar a barrel, compared with a Organization of Petroleum
Exporting Countries (OPEC) price band range of $22 to $28 a barrel.
Adopting the large-scale industrialization and diversification option seemed
then, on the surface, to have been the most viable option, with significant
discernible advantages. The negative factors that have crept into this strategy
over time are now causing the most concern. As will be discussed later, issues
of mismatch between domestic labour supply and market needs, the continuing
strain on balance of payments due to large expatriate labour remittances,
institutionalized inefficiencies and, despite diversification, continuing reliance
on oil and oil derivative exports are features of the Saudi economy today. Most
of these problems are inherited from the earlier development plans. The
section that follows discusses the planning process in more depth.
The history of Saudi planning
Saudi Arabia has undergone a substantial and fundamental transformation
over the past three decades since planning was first introduced in 1970. The
history of development planning has also seen some radical changes, from
directive to indicative planning. Those who were involved in the First Plan
admitted that, in essence, the First Plan of 1970 – 1974 was essentially “an
exploration, theoretical and empirical”, and that the biggest achievement was
“the experience gained by Saudis in the field of development planning” (Farsi,
1982). Others are more critical of the whole planning exercise, arguing that the
development plans demonstrated good intentions, but did not pave the road to
major progress (Cordesman, 2003).
There are those who argue that Saudi Arabian planning has been more “a
macroeconomic exercise than a form of detailed microeconomic management”
(Wilson, 2004). The argument is that Saudi planning involves designing public
expenditure programmes in the light of anticipated revenues and then
18 The Saudi Arabian Economy
executing these expenditures. If revenues are actually achieved, then all is
well: projects are implemented and delayed projects restarted. Conversely, if
anticipated revenues do not materialize, then the opposite happens: ongoing
projects are delayed and new ones suspended.
Planning, however, can be carried out under various models and
circumstances, ranging from setting targets for the economy as a whole and
providing direction on how resources will be invested, to establishing targets
for input resources and the desired output. The Saudi model has not established
precise qualitative output targets, but rather quantitative output targets.
Planning can also follow an indicative direction on how and where the
government wishes the economy to go, providing the necessary rules and
regulations to allow the private sector to achieve those directions
(Osama, 1987).
Planning exercises do not operate in a vacuum and it is important to
analyse the administrative structure under which Saudi planning is carried out.
The first planning exercises, in the late 1950s and early 1960s, depended
heavily on external bodies and consultants such as the Ford Foundation, the
United Nations Team for Social and Economic Planning and the World Bank.
In 1961 a Planning Board was established in Saudi Arabia and in 1965 it was
incorporated into the Central Planning Organization (CPO), which drafted the
Kingdom’s First Five Year Plan in 1969.
In 1975 the CPO became the Ministry of Planning (MOP), reflecting the
importance national planning was being assigned, although some argue that the
Ministry of Planning in effect took a back seat to the actual implementation
policies undertaken by the more powerfiil spending Ministries such as
Commerce, Industry and Electricity (Wilson, 2004). One factor could have
been the lack of interaction between the Ministry of Planning and the Saudi
public in initiating and formulating plan objectives. It is most likely that in an
attempt to try and overcome this gulf between planners and those whose lives
are being most affected, the Ministry of Planning fimction and role was
increased when it was given the extra portfolio of “National Economy.” It is
now known as the Ministry of Planning and National Economy, following the
Saudi Cabinet reshuffle of April, 2003 (Saudi Press Agency, 1 May 2003). The
importance of planning had come fiill circle. The Ministry’s added
responsibility underscores the importance of some of the urgent economic
tasks that need addressing in the new millennium. A new bolder vision is
needed in Saudi Arabia today, one which is comparable to some of the early
initiatives taken, raising whole industrial infrastructures out of the desert, to
become the world’s most modem petrochemical complexes, as embodied by
today’s industrial cities of Jubail and Yanbu.
To reinforce the importance of involving Saudi Arabia’s key decision
makers in the planning and implementation process, the Supreme Economic
Economic Planning: History, Role and Effectiveness 19
Council was established in August, 1999, which included Crown Prince
Abdullah as Chairman, Second Deputy Premier Prince Sultan as Vice
Chairman and the Ministers of Finance, Planning and Economy, Commerce,
Labour, Petroleum and Industry as well as the Governor of the Saudi Arabian
Monetary Agency (SAMA). The critical role of planning could not have had
better support, compared to those earlier days.
Plan achievements
Actual expenditures made by the Saudi government over the whole
planning period from 1970 to date have been impressive, standing at around
SR 2,613 billion or $697 billion. This is set out in more detail in Table 2.2 for
each planning period, organized by broad expenditure categories.
From Table 2.2, it becomes evident how closely government expenditure
patterns follow the fortunes of the Kingdom’s oil revenues, with the current
Seventh Development Plan (2000 – 2004) not reaching the peak “boom years”
of the Third Development Plan period (1980 – 1984).
It is even more important to analyse the different emphases placed during
each planning period, reflecting national priorities. This is set out in Table 2.3,
which captures key “planning indicators” for each plan. It demonstrates that
the planning focus has shifted towards allocative efficiency, human skill
upgrading and private sector participation in economic diversification. The
principal underlying themes of all plans continue to emphasize raising the
standard of living of the people, improving general quality of life and
enhancing their skill capabilities.
The importance of safeguarding Islamic values, cultural heritage and
traditions continues to be emphasized at the outset of each plan. The intension
was to promote economic development, but not “Westernization” – something
which other traditional societies undergoing rapid development have found
difficult to avoid. The Internet revolution makes maintaining a social status
quo even harder, and Saudi society is no exception (Yamani, 1998, 2000,
Rasheed, 2002). The recent advances made by Internet and global
communication have broken down barriers; the IT revolution is one that few
Saudi planners can ignore in the fiiture. The impact of this flow of information
has been researched in other Arab societies with social customs and traditions
similar to that of Saudi Arabia; IT access has had a profound societal shaping
effect (Masmoudi, 1998, Azzam, 2002).

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