The Window is Closing for Riyadh

The oil won’t last forever -- so Saudi Arabia’s government has to reform its economy if it wants to survive.


With its coffers still overflowing, Saudi Arabia appears to have avoided contagion from the Arab Spring through massive government expenditures —what amounts to hush money for disaffected youth and minorities. But the country’s surface calm is just that; peek a few metaphorical inches down, and one discovers a dysfunctional society that is becoming unmanageable.

Initially caught off guard when the Arab Spring movement erupted in early 2011, Saudi officials scrambled to stave off unrest in the way that comes naturally to this authoritarian kingdom awash in oil revenue. Their response focused largely on the immediate problem of easing the country’s surprisingly high unemployment, shelling out $120 billion on social programs, government and private-sector job creation schemes, and subsidies to household income. But pouring money on the problems goes only so far; the economy must find better ways to cope with an entitled, skill-short Saudi workforce, not to mention religious restrictions that constrain efforts to modernize the economy. Indeed, a little over a year after the pot boiled over in Tunisia, new danger signals are emerging, prompting Maplecroft, a political risk assessment consultancy, to rank the kingdom 15th out of 15 emerging market economies — below Nigeria and Iran. A more nuanced approach, one that walks the tightrope between reform and the country’s byzantine interest group politics, will almost surely be needed if Saudi Arabia is to adjust to the realities of the post-Arab Spring Mideast.

Many of Saudi Arabia’s domestic problems stem from demographics. The country’s citizenry grew from 15 million in 1990 to 28 million in 2011, an average annual increase of nearly 3 percent. That pace would be manageable in an economy that was on the familiar developing-country track, of rapid modernization of agriculture combined with labor-intensive manufacturing growth. But it’s proved a daunting problem in an economy dominated by oil.

Saudi Arabia arguably has the financial wherewithal to skip the intermediate steps to industrialized country status. But the key to pulling off this trick is the rapid accumulation of human capital, along with the growth of a highly productive private sector. And thus far, Saudi Arabia’s largely religious, tradition-bound educational system has been slow to modernize, leaving most graduates sorely under-skilled and most businesses hiring workers from other countries.

The government has attempted to compensate for the skills deficit by heavily subsidizing higher education. An estimated 800,000 Saudis are enrolled in universities at home, with another 110,000 in school abroad. But the system falls way short; even those who graduate typically can’t find jobs because they can’t perform to global standards. Tellingly, 90 percent of Saudis currently in prison have university degrees.

Unofficial figures peg youth unemployment as high as 40 percent. Their time in economic limbo is softened by the government’s generous social spending. But it’s hard to imagine that welfare-as-usual is sustainable indefinitely. In part, that’s because most long-term unemployed are demoralized by their marginal role in society; in part, because the government’s coffers aren’t bottomless.

The government’s primary weapon in addressing unemployment has been "Saudization," a carrot-and-stick approach to persuading employers to replace foreign laborers with Saudi nationals. Saudization programs have been around for years, but apparently to little consequence. The original goal was to pare the job roles by 320,000 foreign workers between 1995 to 2000, replacing them with Saudis. In fact, the number of immigrant laborers actually grew by 58,000 during this period.  In the early 2000s, Saudi Arabia’s consultative assembly, the Majlis as-Shura, decreed that Saudi nationals must comprise 70 percent of the country’s workforce by 2007. But employers have found ways around the mandate, and today, Saudis account for only 10 percent of private sector employees.

It’s easy to see why Saudization has failed to meet its targets. The program levies fines on employers that are out of compliance — what amounts to a tax by another name. Many businesses have relocated to avoid it, with most moving to the business-friendly United Arab Emirates, where they have no obligation to replace skilled foreign workers with more expensive, less qualified locals. Firms that do attempt to comply, by offering training for their Saudi workers, find retention difficult, as their best employees are bid away by other enterprises seeking to meet their Saudization quotas.  But even businesses determined to play by the rules are often stymied by regulations that change without warning.

The government’s immediate response to the Arab Spring was to double-down, rolling out a new, more bureaucratic version of Saudization (dubbed the Nitaqat program) that is designed to close loopholes. It’s hard to imagine it will succeed, though, at boosting private-sector employment when previous versions have failed so miserably. To make things worse, Nitaqat works at cross-purposes with other government initiatives —in particular, a big, job-killing hike in the minimum wage and an expansion in high-paying government positions.

A longer term program for reducing the distortions in the Saudi labor market, dubbed the "new economic cities" program, holds more promise. The program takes its inspiration from the success of Jubail and Yanbu, industrial cities created from scratch in the 1970s. More than 30 years in, initial skepticism as to their economic viability has been dispelled thanks to the successful development of downstream industries (notably petrochemicals) that feed off the oil industry. To date, the two cities have created over 100,000 jobs in 233 businesses, many of which are competitive in export markets.

The Saudis are now aiming to mimic these earlier successes more rapidly and on a bigger scale — this time with an emphasis on preparing Saudi Arabia for a post-oil future. The new cities are to serve as the basis for creating a modern knowledge economy. Located in areas that now trail the rest of the kingdom in economic activity, they will support a diversified mix of industries that can fit Saudis into their workforce. The government is plainly serious: In 2008, it allocated $400 billion to fund the program through 2013, after which it hopes to attract private investment to complement ongoing government support.

The new cities program is especially important in light of the kingdom’s fiscal outlook. Riyadh-based Jadwa Investment estimates that Saudi finances will remain viable for the next decade under reasonable assumptions about the future price of oil. Thereafter, all bets are off: Oil revenues are projected to decline, even as the population continues to grow. Saudi Arabia’s estimated breakeven, inflation-adjusted oil price will increase from a manageable $90.70 a barrel in 2015, to $175.10 in 2025 and $321.70 by 2030 — numbers that, at least for the moment, are off the prognosticators’ charts.

The Saudis thus face a relatively rapidly closing window to make the transition to an economy less dependent on oil and more capable of diversified, job-creating growth. The good news is the new cities program may pay off within a decade, before the government budget is likely to slip into chronic deficit. For while Jubail and Yanbu took 15 to 20 years to come into their own, the government now has considerably more expertise and resources at its disposal to undertake ventures of this size and scope.

The Saudis’ problem is analogous to the one we will all face from global warming. Year-to-year developments don’t produce enough change to yield the collective will to face the issues squarely; yet the endgame is not in doubt.

Actually, Saudi Arabia’s dilemma is bleaker. Unless climate change triggers truly unmanageable consequences, rich nations will be able to mitigate the problem by throwing money at it. Saudi Arabia’s failure to make the transition to a modern, diversified economy, by contrast, will almost certainly open the door to religious and tribal conflict that will be very hard to close.

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