The Gulf Club

A new Middle East common market is emerging despite only scattered economic modernisation. With the price of oil blasting off and another Asian powerhouse emerging, The Diplomat Analytical Unit gives us the good oil from - an Australian perspective.
But before we get into that, are you aware that in December 2007 the GCC (Gulf Cooperation Council), which includes Saudi Arabia, Qatar, Bahrain, Oman, Kuwait, and the United Arab Emirates, decided to proceed to a full common market on Jan. 1, 2008? Founded in 1981 the GCC has been a loose security and economic grouping, but the new agreement will make it a far more important and cohesive body. The total economic output (or gross domestic product) of the GCC states this year will be around $800 billion, which makes them an economy close to the size of India in dollar terms.
The Gulf Co-operation Council states, whose wealth is largely based on oil, say the move will give them a stronger negotiating position internationally. It means the right of all GCC citizens to live and work anywhere in the GCC, to buy and sell real estate and make other investments, to move freely between the countries, and receive education and health benefits.
International trade is also likely to get a boost, as it will be easier to trade with the GCC because there will be only one entry point for trading. The GCC is also likely to see a major increase in foreign direct investment. The effects of Opening up the services industry to competition could also be 'enormous,' especially in the banking and financial sectors. Another key aspect of the common market will be its impact on labour movements, which if effective will achieve a better skill mix, which will result in increased productivity at lower costs. It will also mean their citizens can move freely between the countries for employment and education.


The Gulf Club
The soaring price of oil has put Gulf states into the position of dealing with vast surplus wealth that, at the very least, require considerable skills of modernism to manage. It is one of the great transfers of wealth in modern history.
According to investment bank Goldman Sachs, consumers from the developed world are handing over about $US1.8 trillion a year to oil producers, about twice the US current account deficit. This is only likely to accelerate.
The oil price, which has already risen fivefold from its 2003 level, is continuing to climb, possibly heading towards $US200 a barrel. In the 1990s, it fell as low as $US9 a barrel. Little surprise that foreign assets have reached $US1.8 trillion, more than 1 per cent of global capital stock.
Having experienced severe cyclical shifts over the last four decades, the challenge facing the states of the Gulf Cooperation Council (GCC) is to invest the money in a way that will create sustainable economic growth. It will not be easy.
The greatest challenge is probably financial. Countries in the region have immature capital markets. The bond and stock markets are small, and there is a heavy reliance on bank debt. The Gulf states’ currency pegs to the US dollar, which are fixed on the capital account, are also tacit recognition of how immature their financial systems are.
In this sense, the Gulf states resemble another emerging powerhouse, China, which also fixes its currency to the greenback. In other respects, however, the challenge facing the region is the opposite. China is in a furious race to industrialise to raise the standard of living of its vast rural population; its political stability depends on being successful. By contrast, the Gulf states have comparatively small and wealthy populations. They are attempting to move to a post-industrial world in which they can manage their wealth for sustainable advantage.
The difficulty is to manage social dislocation as much as economic change. The Gulf states have, in effect, skipped the industrial era within their own countries because they were supplying the energy for the industrialisation of most of the rest of the world. They moved from a pre-industrial economic structure to a partial post-industrial structure.
The challenge now is to fill in the inevitable gaps. One is to diversify away from their extreme dependence on oil. Robert Newton, chief executive of the Australia Arab Chamber of Commerce, says hydrocarbons remain a “very strong” element in their economies. “Six economies represent half of OPEC’s reserves,” he says. “If they can unify their policies they can be even more effective in their impact on the global economy. Thirty-five million in population is not huge but the buying power there is massive.”
Newton says the level of reserves differs between countries. In the United Arab Emirates (UAE), Dubai is not well endowed with oil but is actively moving into other areas, especially construction. It is the location of a quarter of the world’s cranes and is adding population at the rate of 800 people a day, the fastest growth rate in the world. UAE non-oil exports were 47 per cent of gross domestic product (GDP) in 2007. The hope is to raise this to 70 per cent GDP by 2010.
Kuwait has 10 per cent global crude reserves and is one of the big oil economies alongside Libya, Iran, Iraq and Saudi Arabia. Newton says “there is a push to diversify the economic base – moving from refining, petrochemical to agriculture, fishing, tourism, mining”.
In Saudi Arabia, Newton says there have been “huge strides to industrialise, modernise and reform”. But perhaps of all countries in the region, the shift to post-industrial economic structures is clashing most with pre-industrial social habits. “Reform is assessed as a destabilising factor in society,” Newton says. “It is the custodian of the highest Muslim shrines, and that has a bearing on the government to take a cautious approach to modernising issues. There is a need to avoid going too fast in some areas.” Saudi Arabia is selectively secularising education. It is diversifying into heavy industry capacity, manufacturing of fabricated metal products, jewellery and gold, and foodstuffs. “There are all sorts of opportunities for companies in IT and security, in logistics or utilities,” Newton says.
There are also signs of liberalisation in the non-oil mining sector. Andrew Thomson, Chairman of Gulf & Asian Mining Ltd, says Saudi Arabia has changed its laws to allow foreign investment in mining. Before, only state monopolies were allowed. He says Australian-listed company Citadel Resources Group is now operating in the country. “It’s not easy to operate in Saudi Arabia. You don’t need a Saudi partner, you can have 100 per cent ownership, and it has a very modern regulatory environment. But it is very tough environmentally – it is so hot, more than 50 degrees, that they have to work drilling rigs at night.”
The greatest imperative for Gulf states is to modernise their financial systems, without which they will have to continue to send their savings offshore, contributing to global imbalances. Several commentators have drawn an analogy with the 1970s excesses. Instead of the petrodollars going to doubtful Latin American governments, they are going to doubtful sub-prime mortgages in America. But the destabilising effects have been similar.
Soaring inflation is just one indication of the financial stress that is being created in countries that lack developed financial markets. For example, according to a recent poll, 42 per cent of expatriates who have gone to the UAE in search of a better living are not saving, 17 per cent are going into debt and 28 per cent have sent their families out of the country because of rent increases. Just as a massive inflow of money is transforming these countries, so the ability to manage funds effectively will determine the sustainability of their living standards.
A further measure of the patchy nature of economic modernisation is the surprisingly high levels of unemployment. In Saudi Arabia, unemployment is estimated at 9-12 per cent. The construction industry almost exclusively employs less expensive foreign labour.
Australia has 350 companies operating in the UAE and 17,000 nationals, but the business links are immature. Thomson says the “retail funds industry is not well developed, which is a good opportunity for Australian financial services”. However there are no Australian securities brokers in the region; everything is done out of London. He says during summer there are many UAE visitors to Australia. “They feel very comfortable (here), but for business, it’s early days.”
Australia has proven a useful base for global companies looking to penetrate the Middle Eastern market. Kristian Aquilina, export manager for Holden Australia reckons that over the last three years Holden has sold around 30,000 cars annually to the Middle East. Sales are likely to dip this year, however, because of our strong currency. “We will probably miss out on the current oil boom because of the strength of the Australian dollar.”