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Saudi Arabia’s crisis is economic and demographic

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On November 7, 2018, AEI’s Karen Young participated in the Hoover Institution’s panel, “Saudi Arabia in crisis.” The panel was moderated by Samuel Tadros of the Hoover Institution, and included Elliot Abrams of the Council on Foreign Relations and Simon Henderson of the Washington Institute. Dr. Young’s remarks and commentary are presented below. A recording of the event can be viewed here.

There is an assumption in Washington that Saudi Arabia is in a state of crisis. The US-Saudi bilateral relationship is shaken, but the outrage over the murder of Jamal Khashoggi has also seeped into Saudi domestic politics, not in an upheaval in the leadership or direct threat to the crown prince, but in an increasing awareness on the part of the king that citizens need reassurance. The king and crown prince are currently on a “listening tour” of the country, meeting citizens in traditional receptions. Like the United States, domestic politics in Saudi Arabia are in a period of flux, driven by demographic changes, economic challenges, and an attempt to redefine national identity. This is not too different from some of the challenges Americans are facing. People have anxiety about jobs, about competition, and about their country’s role in international peace and security.

While we withdraw inward, Saudi Arabia has been opening and engaging outward, in military intervention in Yemen, in aggressive foreign policy towards its neighbor Qatar, and in efforts to liberalize its economy, both as a destination for foreign investment and as a source of outwardly placed international capital for new technology. The Khashoggi murder and public outrage has put Saudi Arabia, and its crown prince, on the spot. Saudi Arabia is in a defensive position.

The subsequent media attention has inflated the global economic position of Saudi Arabia, and probably the nature of its ties with the United States. Saudi Arabia is an important partner in the Middle East for the United States, without a doubt. We have some very important economic ties, particularly as the government of Saudi Arabia is a major investor in US securities, both debt and equities. Saudi Arabia and its sovereign wealth fund the PIF are also increasingly important investors in US technology firms and in global capital invested in infrastructure and downstream energy products.

But, the reasons for the US to maintain its close ties with Saudi Arabia reflect more on Saudi Arabia’s regional political leadership position, its impact in oil markets, and the ripple effects of its economic stability on the wider MENA region. As far as US corporate interests (and broader US economic interests) in Saudi Arabia, these are more limited. Yes, Saudi Arabia has provided some lucrative engagements for consultancies and investment banks. (Saudi Arabia and its GCC neighbors now account for about 25 percent of emerging market bond issuance over the last two years, $144 billion of it.) Yes, Saudi Arabia is an important market for defense sales. However, these are a few industries among many; Saudi Arabia does not have the ability to significantly alter the financial stability of the United States.

We should care about Saudi Arabia for the role it plays in the Middle East, as an agent of development finance (which I outlined here), as a partner in global energy supply, as a source of remittances for poorer countries, and as a political force countering Iran. Mohamed bin Salman may be a part of that, but his success or failure depends more on his domestic constituency, his ability to engender and maintain loyalty, and his father’s approval.

Which leads to the evaluation of his core domestic agenda: economic reform and the Vision 2030 development plan. These plans include: the reduction of wasteful energy subsidies, creating alternative sources of government revenues through fee structures and a five percent value-added tax, efforts to attract foreign direct investment, and the Public Investment Fund as a magnet and engine for domestic economic growth. The agenda intends to address core vulnerabilities in the Saudi political economy: a labor market that is bifurcated between nationals and foreigners, unable to provide jobs and social inclusion for young people, with a heavy dependence on oil revenues for all economic activity and state spending, and a trajectory that is unstainable, both in political and economic terms.

We should be focused on the 10 million Saudis under 35, who in twenty years will be facing retirement (if they do indeed find work.) Declining birth rates, a side effect of women’s economic inclusion and cultural shifts, mean there will not be a new generation to support the current youth bulge as it ages. They risk becoming a lost generation; unemployed, part of a public health burden (as many are likely to be diabetic and in ill health), and left behind as global growth heads east. A 2013 study found that $1 in every $11 in Ministry of Health expenditure was on diabetes care in Saudi Arabia. This is the Crown Prince’s generation. As he consolidates power, with his father’s skillful elimination of the previous informal institutions of consensus, Mohamed bin Salman accepts this demographic as his governance challenge. Some kind of economic transformation needs to occur.

At the moment, the reform agenda has hit some significant snags, in part because of capital flight and a stagnant business climate. Much of that is market anxiety that is logically linked to foreign policy choices and the consolidation of power via repression among business elites and royals, now exacerbated by the scandal of the murder of Jamal Khashoggi. Authoritarian regimes flourish with elite accommodation; Saudi Arabia right now is not very accommodating.

In the domestic economic agenda, there has been a “right-sizing” of the National Transformation Program again last week, after a first revision in 2017. There has also been a continuation of state spending on social benefits and public sector wages enabled by higher oil prices this year. In effect, the government is spending more than ever, more reliant on oil, and using capital expenditure as a lever for fiscal consolidation. This is a problem because capital expenditure has traditionally been the key source of economic stimulant–big government contracting in infrastructure, new megaprojects to spur economic growth. That is not really happening right now. Instead, debt-financing continues to enable increased fiscal spending and the spending is not on new growth projects, but on existing government commitments in jobs and benefits.

The scale back of the NTP is in its stated targets, 433 initiatives by 2020, based on 37 strategic targets, compared to 543 initiatives and 178 strategic targets announced for 2016. This is in some ways an acknowledgement of the human capital and administrative capacity of the state that have been overwhelmed by Vision 2030. It is also an admission that some of the targets were not feasible, especially in job creation. For female labor force participation, the goal is now 25 percent, down from 30 percent in 2016 and 28 percent in 2017. Currently, Saudi women’s labor force participation is about 20 percent. For Saudi men, it is about 62 percent labor force participation. What this means is that Saudi women citizens in the workforce are actually quite limited, and dual income families will be important to reduce dependency on the state for both employment and social welfare benefits. Public sector salaries are still more than 50 percent higher than private sector, with average public sector salaries about 11,000 SAR/month, and 7,000 SAR/month in the private sector. Another revision of the NTP includes a new focus on health care provision and the privatization of hospitals and likely introduction of private insurance schemes.

Higher oil prices have essentially masked, and supported, increased spending on the wage bill, social benefits and increased military spending. This is the legacy of Saudi fiscal policy that has not budged, but only become entrenched under Mohamed bin Salman’s management. According to analysis by Barclay’s research, oil price recovery in 2018 led to oil revenue increases of about 85bn SAR ($22.6bn) in the first half of 2018, which helped offset increases of 47bn SAR ($12.5bn) in wages and 21bn SAR ($5.6bn) in social benefits. Military spending increased in 2018 by about 30bn SAR ($8bn).

Where else are increased oil revenues also going? They are going directly to support the PIF in its spending spree. There is a good deal of redirection of revenues happening within government funds, all pointing to the priorities of domestic spending on citizens and feeding the growth of the PIF. Despite new debt issuance in September, foreign exchange reserve assets declined, pointing to the reallocation of resources from debt issuance elsewhere in the government. Meanwhile, Saudization policies are creating an exit of expatriate workers, but Saudis are not necessarily taking those roles. In fact, the unemployment rate for Saudi nationals is not improving. Women are more actively seeking work, but not at the pace first outlined or expected by the NTP. The target for unemployment has shifted as well, to 10.5 percent by 2020, up from the hopeful 9 percent in the first version of the NTP, according to Jadwa Investment’s most recent labor market update.

More than adventurist foreign policy or aggressive repression of dissidents or critics at home and abroad, what Saudi Arabia needs is effective financial governance, social policy that looks forward to health and education challenges, and imaginative job creation. There is money to spend, but not at these rates and not for prolonged periods of time, especially if this generation is to achieve its goals.

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