* The views expressed herein are those of the authors and should not be reported as or
attributed to the International Monetary Fund, its Executive Board, or the governments of any of
its member countries.
Annual Meeting of Arab Ministers of Finance
April 2016
Manama, Bahrain
Economic Diversification in Oil-Exporting Arab
Countries
Prepared by Staff of the International Monetary Fund
I N T E R N A T I O N A L M O N E T A R Y F U N D
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
2 INTERNATIONAL MONETARY FUND
CONTENTS
EXECUTIVE SUMMARY __________________________________________________________________________ 3
INTRODUCTION _________________________________________________________________________________ 6
BACKGROUND ___________________________________________________________________________________ 7
A. Stylized Facts About Oil-Exporting Arab Countries _____________________________________________ 7
B. The Case and Context for Economic Diversification ___________________________________________ 13
POLICY DISCUSSION __________________________________________________________________________ 18
A. Macroeconomic Pre-Conditions to Economic Diversification __________________________________ 18
B. Regulatory and Institutional Frameworks Conductive to Private Sector Growth _______________ 23
C. A Public Sector that Enables Private Sector Growth ___________________________________________ 27
D. The Road to a More Diverse Economy ________________________________________________________ 29
CONCLUSION __________________________________________________________________________________ 35
BOXES
1. Measuring Economic Diversification: Concepts and Indicators ________________________________ 11
2. Morocco: Diversifying Away from Phosphate and Agriculture _________________________________ 33
3. Pattern of Diversification of a Resources-Based Economy: Malaysia ___________________________ 34
FIGURES
1. Selected Indicators for Arab Oil Exporters ______________________________________________________ 8
2. Measures of Economic Diversity _______________________________________________________________ 10
3. Projected Impact of the Recent Drop in Oil Prices _____________________________________________ 16
4. Most Problematic Factors for Doing Business in Arab Oil Exporters ___________________________ 25
TABLES
1. Arab Oil Exporters: Key Sectoral Indicators _____________________________________________________ 9
2. Arab Oil Exporters: Selected Economic Indicators, 2014 _______________________________________ 13
APPENDIX
Technical Notes __________________________________________________________________________________ 37
REFERENCES ____________________________________________________________________________________ 39
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 3
EXECUTIVE SUMMARY
Despite their diversity in size, demographics and wealth, most oil-exporting Arab countries
face similar challenges to create jobs and foster more inclusive growth. The current
environment of likely durable low oil prices has exacerbated these challenges.
The non-oil private sector remains relatively small and, consequently, has been only a
limited source of growth and employment. While some countries have made more headway
than others in diversifying their economies, the energy sector, typically highly capital intensive,
remains dominant in many economies. However, it creates few jobs directly, while oil revenue is
often used to finance an oversized public sector. Still, the employment situation varies greatly
across countries: some GCC economies rely on foreign labor to fill private-sector jobs while
other Arab oil exporters need to meet the needs of a fast-growing domestic labor force.
Because oil is an exhaustible resource, new sectors need to be developed so they can take
over as the oil and gas industry dwindles. While some countries have ample reserves,
hydrocarbon resources in a number of Arab countries could be depleted in the foreseeable
future. However, even non-oil activities in many oil-exporting Arab countries are to some extent
dependent on funding from oil revenues. The challenge therefore is to grow truly self-sufficient
non-oil sectors that will provide a sustainable source of growth and employment even when oil
resources are depleted. Moreover, even countries with large proven reserves need to save a
larger share of their current oil income to promote greater intergenerational equity.
Over-reliance on oil also exacerbates macroeconomic volatility. When oil prices drop, as is
presently the case, the related decline in fiscal revenue often requires cuts in public spending,
which dampen growth in the non-oil sector and strain the sustainability of public employment.
Greater economic diversification would unlock job-creating growth, increase resilience to oil
price volatility and improve prospects for future generations. It would also broaden the base for
government revenue thereby reducing the reliance on oil and making the economy more resilient to
oil price shocks.
Macro-economic stability and supportive regulatory and institutional frameworks are key
prerequisites for economic diversification:
Insulating the economy from the impact of oil price volatility is necessary to lay a sound
foundation for economic diversification. It requires sound fiscal policy and framework,
effective liquidity management and prudent monetary policy, supportive financial sector policies
and a fairly valued exchange rate.
Strong regulatory and institutional frameworks are also needed to unlock private sector
potential. Improving the business environment, including streamlining procedures,
strengthening economic governance and transparency, and reducing regulatory barriers to
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
4 INTERNATIONAL MONETARY FUND
competition are needed for the private sector to grow. Labor market reforms and better access
to finance are also necessary.
The public sector should enable, not compete with, the private sector to support economic
diversification. Public employment and wage policies need to be tailored to improve incentives and
help raise the supply of highly-skilled labor for the private sector. Public spending needs to focus on
investment in infrastructure and human capital to improve competitiveness. Reducing excessive
monopoly rents in the nontradable sector by increasing competition and enhancing bidding
procurement processes would also help boost the private sector.
Policies and strategies to foster the emergence of dynamic new tradable sectors could
accelerate economic diversification. Economic diversification requires innovation in processes (to
enhance productivity), products (to sustain growth in new sectors), and organizations (to produce
more efficiently). Strategies could involve seeking to foster horizontal and vertical diversification,
diversifying manufacturing away from oil production, further integrating into the global value chain,
and attracting FDI into the non-oil sector.
The appropriate policy package and the sequencing of reforms need to be designed carefully,
taking into account each country’s specific circumstances and capacities. While the challenges
are similar, the diversity in size, demography, wealth, and economic structure of oil-exporting Arab
countries will warrant tailored responses. Specific recommendations will therefore vary across
countries.
It is acknowledged that economic diversification will not happen without security. Some
countries (Iraq, Libya, and Yemen) are affected by wars that severely disrupt economic activity and
weaken investor confidence. While this paper does not explicitly discuss this issue, it is understood
that restoring political stability and security is a necessary precondition to economic diversification.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 5
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
6 INTERNATIONAL MONETARY FUND
Sources: IMF Regional Economic Outlook database; and Microsoft Map Land.
Note: The country names and borders on this map do not necessarily reflect the IMF's official position. Country ISO-3 codes are in brackets.
Algeria (DZA)
39.5
5,406
Libya (LBY)
6.2
6,671
Saudi Arabia (SAU)
30.8
24,252
Iraq (IRQ)
34.3
6,520
Yemen (YEM)
27.5
1,574
Oman (OMN)
3.7
20,927
Qatar (QAT)
2.2
93,990
United Arab Emirates (UAE)
9.3
42,944
Bahrain (BHR)
1.3
26,701
Population, millions (2014)
GDP per capita, U.S. dollars (2014)
Kuwait (KWT)
4.0
43,168
INTRODUCTION
1. This paper was produced at the request of the Arab Monetary Fund to support a
discussion among Arab Finance Ministers on the key challenges and policy issues related to
economic diversification in oil-exporting Arab countries.
1,2,3
The paper is organized in two parts.
The first part lays out the stylized facts on oil-exporting Arab countries as well as the motivation for
economic diversification. It underlines the heterogeneity in conditions across oil-exporting Arab
countries and therefore the need to tailor policy advice to country circumstances. It emphasizes that
the current context of likely durably lower oil prices increases the need for economic diversification
while reducing the means to promote it. The second part discusses the policies to support greater
economic diversification. It argues that macroeconomic stability and a supportive regulatory and
institutional framework are necessary, but not sufficient conditions for diversification. It then
discusses how the public sector can enable, rather than compete with, private sector development.
Finally, it sketches how the road to a more diverse economy may look like, drawing from other
country experiences.
1
The paper focuses on the countries in the Middle East and North Africa region that export oil. These are: Algeria,
Bahrain, Iraq, Kuwait, Libya, Oman, Qatar, Saudi Arabia, United Arab Emirates, and Yemen.
2
The paper was produced by a team led by Jean-François Dauphin and comprising Jean-Frédéric Noah Ndela,
Xiangming Fang and Greg Auclair, under the supervision of Aasim M. Husain. Kadia Kebet and Geraldine Cruz
provided editorial support.
3
The paper benefited from suggestions made by participants at the meeting of Arab deputy finance ministers that
took place in Abu Dhabi on January 13, 2016.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 7
BACKGROUND
Oil-exporting Arab countries face three-pronged policy challenges: creating jobs in line with rapidly
growing population, sheltering their economy from volatility of oil prices and ensuring sustainable
growth once oil resources are depleted. This section lays out key stylized facts about oil-exporting Arab
economies and makes the case that greater economic diversification would help address these
challenges.
A. Stylized Facts About Oil-Exporting Arab Countries
4
2. Oil-exporting Arab economies are all heavily dependent on oil. In all of these countries,
economic activity, fiscal revenue, export earnings and foreign exchange are directly and indirectly
dependent on oil production to a large extent (Figure 1).
5
Activity. Hydrocarbon and government activities (which are heavily funded by oil revenues)
account for the majority of total GDP in all countries, except in Algeria, Bahrain and Yemen and
the UAE. In Libya for example the non-oil and non-government share in GDP accounts for just
about
1
/
6
th
of total GDP. Furthermore, activity in non-government, non-oil sectors is itself often
dependent on oil as the main sources of manufacturing value-added in Arab oil exporters tend
to include refinery, chemical, and other mining/extractive industries, i.e. activities that derive
from the oil industry and some non oil sectors (e.g., construction in some countries) depend
heavily on government contacts (Table 1).
Fiscal revenue. Oil is the primary source of government revenue in all countries. In 2014, the
share of oil revenue in total revenue ranged from 47 percent in Yemen to 94 percent in Iraq and
averaged 77 percent across the group.
Exports. Similarly, in all countries except the UAE, oil is the main export good. Oil accounts for
above 80 percent of total exports in half of the countries in the group, and above 60 percent in
all of them except the UAE. In the UAE (as in Bahrain), non-oil exports include a large share of
re-exports.
6
4
For cross-country consistency, the data used in this paper draws where available on the October 2015 Regional
Economic Outlook and World Economic Outlook. More recent data vintages may be available for particular countries
and particular data.
5
For simplicity, the paper uses the term “oil” to mean hydrocarbons. In some countries (e.g., Algeria, Qatar),
hydrocarbon production includes a significant share of gas.
6
Re-exports accounted 24 percent of total non-oil exports of the UAE in 2014 according to the UN Comtrade
database.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
8 INTERNATIONAL MONETARY FUND
11%
27%
62%
Algeria
Government Oil Other
11%
24%
65%
Bahrain
12%
47%
41%
Iraq
11%
63%
26%
Kuwait
45%
39%
16%
Libya
11%
56%
33%
Oman
6%
51%
43%
Qatar
12%
43%
45%
Saudi Arabia
3%
34%
63%
United Arab Emirates
10%
19%
71%
Yemen
Figure 1. Selected Indicators for Arab Oil Exporters
GDP Composition of Arab Oil Exporters, 2014
1/
Sources: WEO; and IMF staff estimates.
1/ In absence of consistent data public administration value added, government GDP is proxied in this graph by the
government wage bill. See Appendix 1.
0
10
20
30
40
50
60
70
80
90
100
Non-oil revenue
Oil revenue
Oil and Non-Oil Fiscal Revenue, 2014
(Percent of total government revenue)
Sources: WEO and IMF staff estimates.
0
10
20
30
40
50
60
70
80
90
100
Oil and Non-Oil Exports, 2014
(Percent of total)
Non-oil exports
Oil exports
Sources: WEO and IMF staff estimates.
Advanced Countries
SSA
GCC
Non-GCC Arab OEs
MENA OIs
EMDCs
LICs
EMD Asia
DZA
BHR
IRQ
KWT
OMN
QAT
SAU
UAE
YEM
0
5
10
15
20
25
30
35
40
0 5 10 15 20
Youth Employment Rate (Ages 15
-24)
Total Unemployment Rate
Total Unemployment vs. Youth Unemployment, 2013
(Percent of labor force)
Sources: ILO; World Bank; and IMF staff estimates.
Trendline for all countries
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 9
Table 1. Arab Oil Exporters: Key Sectoral Indicators
3. Reflecting the predominance of the oil sector, economic diversification is generally
low in oil-exporting Arab countries (Figure 2, Box 1). Although some countries have made more
headway than others in diversifying their economies, most indicators of economic complexity,
diversity, and export quality are lower in oil-exporting Arab economies than in many emerging
market economies, including other countries in the region and commodity exporters in other
regions.
7
Furthermore, as discussed below, the integration in global value chains remains low.
7
Many oil exporting Arab countries have launched over the years initiatives to support a more diversified economy.
For example, the UAE has promoted the development of industrial zones and the restructuring of industrial sectors;
Algeria implemented large infrastructure projects; in Kuwait, a new Development Plan focuses on large infrastructure
projects and is largely financed through partnerships with the private sector.
Agriculture Industries Services Agriculture Industries
Total
Government
Algeria 8.6 48.3 43.1 14.0 13.4 72.6 32.0
Petroleum, petrochemical, natural gas, light
industries, mining, electrical, and food processing
Bahrain 0.3 47.1 52.2 1.0 32.0 67.0 11.6
Petroleum processing and refining, aluminum
smelting, iron pelletization, fertilizers, Islamic and
offshore banking, insurance, ship repairing, tourism
Iraq 3.3 64.5 32.2 21.6 18.7 59.7 40.0
Petroleum, chemicals, textiles, leather, construction
materials, food processing, fertilizer, metal
fabrication/processing
Kuwait 0.3 49.4 50.2 … … … 27.1
Petroleum, petrochemicals, construction materials
and cement, shipbuilding and repair, water
desalination, and food processing.
Libya 2.0 45.8 52.2 17.0 23.0 59.0 …
Petroleum, petrochemicals, aluminum, iron and steel,
food processing, textiles, handicrafts, cement
Oman 1.3 55.2 43.5 … … … 11.0
Crude oil production and refining, natural and
liquefied natural gas, construction, cement, copper,
steel, chemicals, optic fiber
Qatar 0.1 68.0 31.9 1.3 54.9 43.8 12.1
Liquefied natural gas, crude oil production and
refining, ammonia, fertilizers, petrochemicals, steel
reinforcing bars, cement, commercial ship repair
Saudi Arabia 2.0 59.7 38.3 6.7 21.4 71.9 30.7
Crude oil production, petroleum refining, basic
petrochemicals, ammonia, industrial gases, sodium
hydroxide (caustic soda), cement, fertilizer, plastics,
metals, commercial ship repair, commercial aircraft
repair, construction
United Arab Emirates 0.6 58.9 40.5 7.0 15.0 78.0 28.4
Petroleum and petrochemicals; fishing, aluminum,
cement, fertilizers, commercial ship repair,
construction materials, handicrafts, textiles
Yemen 9.2 26.8 64.0 … … … 12.2
Crude oil production and petroleum refining; small-
scale production of cotton textiles, leather goods;
food processing; handicrafts; aluminum products;
cement; commercial ship repair; natural gas
production
Sources: Authorities' data and IMF staff estimates.
Share of GDP (Percent)
Main industries
Share of employment (Percent)
Services
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
10 INTERNATIONAL MONETARY FUND
DZA
KWT
LBY
OMN
QAT
SAU
UAE
YEM
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
5.25 6 6.75 7.5 8.25 9 9.75 10.5 11.25 12
Economic Complexity, 2014
(higher score = greater economic complexity)
Log of GDP per Capita (in USD), 2010-14
Hydrocarbon exports <25% of total
Hydrocarbon exports >25% of total
Trend for hydrocarbon exporters
Trend for non-hydrocarbon exporters
Economic Complexity Index and GDP per Capita
DZA
KWT
LBY
OMN
QAT
SAU
UAE
YEM
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
5.25 6 6.75 7.5 8.25 9 9.75 10.5 11.25 12
Export Diversity Index, 2014
(higher score = greater export diversity)
Log of GDP per Capita (in USD), 2010-14
Export Diversity Index and GDP per Capita
Hydrocarbon exports <25% of total
Hydrocarbon exports >25% of total
Trend for hydrocarbon exporters
Trend for non-hydrocarbon exporters
Figure 2. Measures of Economic Diversity
Sources: The Observatory of Economic Complexity; The Diversification Toolkit (IMF); UNIDO INDSTAT4 Industrial Statistics
Database; and IMF staff estimates.
Note: Scales for Economic Complexity, Export Diversity, and Export Quality indices are normalized between 0 (minimum
observed valued) and 1 (maximum observed value) to facilitate comparison.
Yemen
Algeria
Qatar
Oman
Kuwait
Saudi Arabia
United Arab Emirates
Morocco
Jordan
Turkey
Indonesia
Canada
Malaysia
Mexico
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Economic Complexity Index
(1 = greater complexity)
Economic Complexity Index
Arab Oil Exporters
MENA Region Other Oil Exporters
Kuwait
Yemen
Saudi Arabia
Algeria
Qatar
Oman
United Arab Emirates
Bahrain
Turkey
Jordan
Morocco
Malaysia
Mexico
Indonesia
Canada
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Export Diversity (IMF)
(1 = greater diversity)
Export Diversity Index
Arab Oil Exporters MENA Region Other Oil Exporters
Yemen
Iraq
Saudi Arabia
Kuwait
Oman
Algeria
United Arab Emirates
Qatar
Bahrain
Morocco
Jordan
Turkey
Indonesia
Mexico
Malaysia
Canada
0
0.2
0.4
0.6
0.8
1
Export Quality (IMF)
(1 = higher quality)
Export Quality Index
Arab Oil Exporters MENA Region Other Oil Exporters
Qatar
Algeria
Oman
Yemen
Kuwait
Bahrain
Saudi Arabia
Morocco
Jordan
Turkey
Mexico
Indonesia
Malaysia
Canada
0
0.2
0.4
0.6
0.8
1
Manufacturing Value Added GINI
(1 = greater inequality between sectors)
Manufacturing Value-Added GINI
Arab Oil Exporters MENA Region Other Oil Exporters
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 11
Box 1. Measuring Economic Diversification: Concepts and Indicators
Economic diversification can be defined and measured in various ways. Beyond simpler measures of sectoral
diversification, this paper measures diversification through four specific indicators from the literature:
1
Economic Complexity Index: This index measures the number of products made by an economy and controls
for the likelihood that the same product is also made by others. Countries that produce goods or services that
are not made elsewhere receive higher complexity scores than countries whose products are widely
manufactured. For example, Germany and Japan have high scores, because they manufacture a wide array of
products that very few countries can make. Like the IMF indices (described below), the Economic Complexity
Index relies on international trade data. It is based on the assumption that countries will export most high-
quality products, and thus, trade data will reflect overall production within the economy.
IMF Export Diversification Index: The IMF Export Diversification Index is calculated using trade data and is a
combined measure of the ‘extensive’ and ‘intensive’ dimensions of diversification (also available as separate
indices):
Extensive export diversification reflects an increase in the number of export products or trading
partners.
Intensive export diversification considers the shares of export volumes across active products or
trading partners.
A country is less diversified when export revenues are driven by only a few sectors, trading partners, and/or
total market share is low. Countries with a large number of exports and trading partners improve their
extensive diversification, which in turn provides resilience to market or trading-partner shocks. Claiming
greater market share (by product or country) increases intensive diversification, which confers greater pricing
power and integration into supply-chains. The Theil index, a measure of inequality, is calculated for the
intensive and extensive components of each country/year pair and summed to create a synthetic indicator.
IMF Export Quality Index: This index describes the average quality within any product category. The baseline
methodology (see Henn et al., (2013) for more details) estimates quality based on trade price, which is
calculated in turn based on three factors: product unit value relative to market prices; exporter income per
capita (as a proxy for differences in production technologies); and the distance between importer and exporter.
Manufacturing Value-Added Gini: This is a Gini index constructed on the relative value-added of different
manufacturing industries within an economy. The data come from the 2015 UNIDO INDSTAT4 Industrial
Statistics Database, which provides manufacturing data disaggregated at the ISIC 3-digit level, including the
total value added of each industry classified. A score of 0 indicates complete equality between industries’
value-added within an economy, while a score of 1 indicates the complete dominance of only one industry.
1/
Henn, C., C. Papageorgiou, and N. Spatafora, 2013, “Export Quality in Developing Countries” IMF Working Paper 13/108.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
12 INTERNATIONAL MONETARY FUND
4. The private sector in most oil-
exporting Arab countries also remains small
in size. Many firms in oil-exporting Arab
countries are state-owned and operate in public
related services and the private sector remains
small in many of these economies. By measures
of average firm size and new firms per 1000
residents, the private sector of oil-exporting
Arab economies tends to be largely informal or
relatively underdeveloped in non-GCC countries.
5. The size of the economies and GDP per capita vary significantly across countries. Saudi
Arabia has the largest economy, with a nominal GDP of US$746 billion while Bahrain is the smallest
of all, with a GDP of US$34 billion. The disparity in 2014 per-capita-GDP is very large: Qatar had one
of the highest per-capita-GDP in the world at close to US$94,000 (and the highest in the world when
measured in purchasing power parity terms).
Conversely, Yemen had a GDP per capita of
US$1,574 in 2014. There were also significant
variations in real GDP-per-capita growth across
countries in the group, but in all countries
except Iraq it was lower than the world average
of 3.1 percent over 2010-14. Over that period,
GDP per capita declined in Yemen and Oman in
real terms. When oil and government sectors
are excluded (as a measure of the wealth-
generating value added produced outside the
oil sector), the remaining GDP per capita is fairly
low in most countries. Only a few Arab oil exporter economies would have per capita GDPs above
the world average.
8
6. Although their sizes vary considerably, populations in most oil-exporting Arab
countries are young and fast growing. In 2014, national population sizes varied from 630,000 in
Bahrain to nearly 40 million in Algeria. With the exception of war-torn Libya, overall populations
tended to grow fast, with average annual growth rates over 2010-14 ranging from 1.5 percent in
Bahrain to 6.6 percent in Qatar. While the source of population growth is domestic in some
countries, like Algeria, a number of Gulf countries rely heavily on migration for labor. Around
10 million migrants are in Saudi Arabia, a third of the total population, while other GCC countries
also host large expatriate populations, often more than half of total population. Overall, the share of
children ages 15 and younger in the national population is high, although in GCC countries, the
large expatriate presence skews the overall population more towards working ages. Populations are
8
The world average total GDP per capita was estimated at 10,848 nominal USD in 2014.
1.1
1.1
2.8
3.5
7.2
11.3
11.7
17.7
27.6
44.4
0
5
10
15
20
25
30
35
40
45
50
Non-Government, Non-Oil GDP per Capita, 2014
(In thousands of USD)
Sources: WEO and IMF staff estimates.
Qatar
United Arab Emirates
Oman
Algeria
Iraq
Turkey
Jordan
Morocco
Canada
Mexico
Indonesia
0
5
10
15
20
New businesses per 1000 residents
New Businesses per 1000 Residents, 2008-12 (Average)
Sources: World Bank Enterprise Surveys; WEO; and IMF staff estimates.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 13
predominately urbanized, except in Yemen. The relatively high fertility rates in a number of Arab oil
exporter countries indicate that their populations will continue to grow in the near future.
Table 2. Arab Oil Exporters: Selected Economic Indicators, 2014
B. The Case and Context for Economic Diversification
7. The oil sector cannot be a sustainable source of jobs to absorb the growing workforce.
The dominance of oil in oil-exporting Arab economies contributes to shape the economic structure
toward energy intensive activities and/or energy dependent services. However, the energy industry,
is typically highly capital intensive and generates fewer jobs than other sectors.
Algeria Bahrain Iraq Kuwait Libya Oman Qatar
Saudi Arabia
UAE Yemen
(In percent, unless otherwise specified)
Activity
Nominal GDP (billions of US$) 213.5 33.9 223.5 172.6 41.1 77.8 210.1 746.2 399.5 43.2
Nominal GDP per capita (US$) 5,406 26,701 6,520 43,168 6,671 20,927 93,990 24,252 42,944 1,574
Nominal GDP (2010-14 average annual growth rate) 11.8 8.2 15.6 10.5 10.3 11.1 17.2 12.2 9.7 13.2
Oil GDP (share of total nominal GDP) 27.1 24.0 46.5 62.9 38.5 56.1 51.1 42.6 34.3 19.5
Non-oil GDP (share of total nominal GDP) 72.9 76.0 53.5 37.1 61.5 43.9 48.9 57.4 65.7 80.5
Real GDP (2010-14 average annual growth rate) 3.1 4.0 6.5 3.4 2.0 4.5 9.3 5.2 4.5 0.4
Real GDP per capita (2010-14 average annual growth rate) 0.8 2.5 3.8 0.6 0.9 -0.7 2.9 2.3 1.9 -2.5
Real oil GDP (2010-14 average annual growth rate) -3.0 2.7 6.0 3.4 11.6 2.8 8.7 3.4 5.0 4.6
Real nonoil GDP (2010-14 average annual growth rate) 6.4 4.4 7.2 3.6 1.0 6.2 10.3 6.8 4.3 0.2
Fiscal revenue (2014)
Oil revenue (share of total)
1
59.2 86.2 94.4 79.8 93.4 87.9 80.3 76.8 63.5 47.3
Non-oil revenue (share of total)
1
40.8 13.8 5.6 20.2 6.6 12.1 19.7 23.2 36.5 52.7
Export of goods and services (2014)
Oil and gas exports (share of total) 91.8 60.9 95.1 87.8 97.2 60.5 85.7 80.2 28.5 72.9
Non-oil exports (share of total) 8.2 39.1 4.9 12.2 2.8 39.5 14.3 19.8 71.5 27.1
Demographics
Population (millions) 39.5 1.3 34.3 4.0 6.2 3.7 2.2 30.8 9.3 27.5
of which: nationals (millions) 39.4 0.6 … 1.3 … 1.9 0.2 20.7 1.3 …
Population (2010-14 average annual growth rate) 2.3 1.5 2.6 2.8 0.7 5.3 6.6 2.9 2.6 3.0
Population share ages 15 and younger (2013) 27.8 21 40.1 24.8 29.4 23.5 13.6 29 15.3 40.2
Fertility rate (2012, births per woman) 2.8 2.1 4.1 2.6 2.4 2.9 2.0 2.7 1.8 4.2
Unemployment rate (2013) 9.8 3.8 16.0 3.1 19.6 7.9 0.5 5.7 3.8 17.4
Youth unemployment rate (2013, ages 15-24) 24.0 27.9 34.1 19.6 51.2 20.5 1.5 28.7 9.9 29.8
Sources: ILO; World Bank; WEO; and IMF staff estimates.
1
Calculated from central government revenue for Algeria; otherwise general government is used. Oil GDP and revenue includes all hydrocarbons (oil and gas).
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
14 INTERNATIONAL MONETARY FUND
Arab Oil Exporters: Oil GDP and Employment in Extractive Industries
(Share of total GDP and employment, percent)
Sources: ILO; WEO; and IMF staff estimates.
8. Furthermore, a significant share of employment in many countries is provided by the
government, financed through volatile and exhaustible oil revenue. In many oil-exporting Arab
economies, the public sector is a major source of employment. In Algeria and Iraq for instance, the
public sector absorbs more than 40 percent of total employment. On average elsewhere in the world,
about 90 percent of the jobs are provided by the private sector.
9
The fiscal cost of government
employment is mostly financed by volatile oil revenue. Maintaining the level of public employment
steady, as governments typically seek to do, transfers oil revenue volatility to the budget balance. At
the same time, the exhaustibility of oil resource jeopardizes the sustainability of public employment
in the long run while the domestic workforce in many oil-exporting Arab countries is typically young
and set to continue growing rapidly.
9
World Bank, 2012.
Oil GDP Non-oil GDP
Employed in extractive industries
Employed elsewhere
0.0
0.5
1.0
1.5
2.0
2.5
2015 2016 2017 2018 2019 2020
Public sector jobs
Private sector jobs
Gap
Sources: National authorities; and IMF staff calculations.
1
Note: Data for U.A.E. not included. Public sector jobs are projected by using historical growth rate (4.6%), while private sector
jobs are projected by using historical employment-non-oil growth elasticities and non-oil growth current WEO projections
(as in Behar, 2015).
2.15 million new entrants into labor force between 2014 and 2020
Illustrative Employment Outlook in the GCC
(Millions of new labor market entrants, cumulative)
0
10
20
30
40
50
60
70
80
90
100
Public Sector Employment
(Share of total, 2012 or latest data available)
Public sector share of
total employment
Public sector share of
employment of nationals
Sources: ILO; UNDP; authorities' data; and IMF staff estimates.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 15
9. A competitive private sector would provide a more sustainable source of growth and
employment. In most economies in the world, services in the private sector lead job creation,
followed by manufacturing, with the share of the agriculture typically declining. Within the private
sector, small and medium enterprises (SMEs) are the primary source of job creation.
10
This suggests
that greater economic diversification, reflected in a private-sector driven economy operating in a
wide range of profitable sectors, would provide a more sustainable source of productive jobs,
reducing total employment’s exposure to volatile and exhaustible source of financing.
10. Greater economic diversification would shield the economy from the volatility of the
global oil market. Wide fluctuations in hydrocarbon prices is a key source of macroeconomic
volatility, notably in the fiscal and external sectors given the high dependence of fiscal and export
revenues on oil prices. When oil
prices drop, as they did in 2014,
oil-exporting countries experience
significant decline in government
revenue, public spending
(consequently), current account
balance and (potentially)
international reserves. Shrinking
oil revenues affect domestic
consumption as many jobs in oil-
exporting countries are directly or
indirectly linked to the
performance of the oil sector. In
downturns, many job seekers may
have fewer job opportunities,
which means less income and little
prospect for increasing households’ wealth. For example, the GCC countries experienced a long
decline in consumption per capita in the early 1980s and returned to the early 1980s level only in
the late 2000s, well after the oil price boom began.
11
Furthermore, lower fiscal spending (e.g., cut in
public investment programs) also weighs on economic activity in the short run and may reduce
medium-term potential growth. Reducing the reliance on oil revenue through greater economic
diversification is an important way of fostering a more stable economy.
10
IFC 2013: Jobs study.
11
IMF 2014: GCC diversification.
DZA
KWT
LBY
OMN
QAT
SAU
UAE
YEM
0
1
2
3
4
5
6
7
8
9
10
-2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5
Standard Deviation in Investment Expenditure 2005
-14
(percentage points of GDP)
Economic Complexity
Volatility of Government Investment Expenditure
and Economic Complexity, 2014
Hydrocarbon exports <25% of total
Hyrdocarbon exports >25% of total
Sources: Observatory of Economic Complexity; WEO, and IMF staff estimates.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
16 INTERNATIONAL MONETARY FUND
Figure 3. Projected Impact of the Recent Drop in Oil Prices
Sources: WEO; and IMF staff estimates.
11. Diversification would also sustain economic growth when oil resources are depleted.
As oil is an exhaustible resource, oil revenues will eventually dwindle. While some oil-exporting Arab
countries have a long oil production horizon, hydrocarbon resources in a number of others
(e.g. Bahrain, Oman) are expected to be depleted in the foreseeable future. Governments’ resources
will diminish and their capacity to support economic growth will be impaired. Sustaining growth
requires developing new sectors to take over and provide alternative sources of revenues as the oil
and gas industry dwindles. Strong private investment should become the impetus for growth when
high public investment can no longer be maintained. Moreover, it would raise non-oil production
and compensate the eventual loss of government revenue from the oil sector. A dynamic and
diverse export sector would help preserve the sustainability of the current account and provide a
more steady source of reserve accumulation. Moreover, even countries with large proven reserves
need to nurture the development of a vibrant non-oil sector to provide suitable employment
opportunities for their citizens.
$30
$40
$50
$60
$70
$80
$90
$100
$110
$120
30
40
50
60
70
80
90
100
110
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
GCC: Government Revenue and Expenditure
(Percent of non-oil GDP, weighted average)
GCC Total Expenditure
GCC Revenue
Brent price (USD, RHS)
Sources: WEO and IMF staff estimates.
$30
$40
$50
$60
$70
$80
$90
$100
$110
$120
30
40
50
60
70
80
90
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
MENA (excl. Libya): Government Revenue and Expenditure
(Percent of non-oil GDP, weighted average)
MENA Total Expenditure
MENA Revenue
Brent price (USD, RHS)
Sources: WEO and IMF staff estimates.
$30
$40
$50
$60
$70
$80
$90
$100
$110
$120
0
10
20
30
40
50
60
70
80
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Reserves of Arab Oil Exporters
(Percent of GDP, weighted average)
GCC
MENA (excl. Libya)
Brent price (USD, RHS)
Sources: WEO and IMF staff estimates.
$30
$40
$50
$60
$70
$80
$90
$100
$110
$120
-20
-15
-10
-5
0
5
10
15
20
25
30
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Current Account Balance of Arab Oil Exporters
(Percent of GDP, weighted average)
GCC
MENA
Brent price (USD, RHS)
Sources: WEO and IMF staff estimates.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 17
12. The current environment of lower oil prices adds urgency to long-standing efforts to
diversify oil-exporting Arab economies. Oil prices have dropped dramatically since mid-2014.
Going forward, oil prices are expected to remain low, increasing only modestly over the medium
term. Therefore, oil exporters need to adjust their policies to preserve macroeconomic stability.
Absent adjustment, and with the exception of Kuwait, Qatar, and the UAE, oil-exporting Arab
countries could substantially run down their fiscal buffers in the next five years or less. Thus, the
need for significant fiscal consolidation and external sector adjustment implies a more constrained
context for promoting economic diversification given the reduced fiscal space to support it. Fiscal
consolidation will also weigh on growth, adding urgency to the implementation of structural reforms
to boost potential growth and employment. Nonetheless, the current environment provides an
opportunity to move ahead with some difficult but necessary reforms, notably that of energy
subsidies.
0.15
0.16
0.17
0.18
0.19
0.20
0.21
0.22
0.23
1990
1993
1996
1999
2002
2005
2008
2011
2014
2017
2020
2023
2026
2029
2032
2035
2038
Oil Production per Capita for Arab Oil Exporters
(Barrels per day per capita)
projection →
Sources: World Bank; IEA; and IMF staff estimates.
Note: Projections for oil production use the IEA 'new policies' scenario.
0 20 40 60 80 100 120 140 160 180
Bahrain
Oman
Algeria
Yemen
Saudi Arabia
Qatar
UAE
Iraq
Kuwait
Libya
Gas Oil
Remaining Years of Oil and Gas Production, 2012
(Years; based on 2012 production levels)
Sources: BP 2013 Statistical Review; and IMF staff estimates.
Note: Gas production for Iraq assumes 46 billion cubic meters per year (the
regional average production). Countries sorted based on total remaining years.
0
20
40
60
80
100
120
140
2013 2014 2015 2016 2017
68% confidence interval
86% confidence interval
95% confidence interval
Futures
Sources: Bloomberg; IMF RES Commodities Unit, and staff calculations.
1/ Derived from prices of futures & options on January 12, 2015.
WEO Baseline
2015: $51.79
2016: $29.92
Brent Crude Oil Price 1/
(U.S. dollars per barrel)
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
18 INTERNATIONAL MONETARY FUND
POLICY DISCUSSION
A. Macroeconomic Pre-Conditions to Economic Diversification
This section discusses the macroeconomic pre-conditions to economic diversification. Drawing from the
existing literature, it argues that fostering macro-stability and insulating the economy from the impact
of oil price volatility is necessary to lay a sound foundation for the diversification of oil-exporting Arab
countries. It briefly discusses the policies needed to achieve such stability, including the appropriate
fiscal policy and framework, effective liquidity management, supportive financial sector policies,
including macro-prudential policies, and the need for a fairly valued exchange rate.
13. Macroeconomic stability and economic diversification reinforce each other. Empirical
evidence shows that countries with a diversified economic structure are more resilient to exogenous
shocks. Indeed during the great recession in 2008-09, economies with a more diversified export
structure weathered better international trade shocks.
12
Moreover, output volatility tends to be
lower in economies with a more complex structure. Likewise, volatility of government revenue
diminishes as an economy becomes more complex and diversified. In this regard, the relatively high
volatility in output and government revenue observed in oil-exporting Arab economies during
2005–14 could be partly explained by a lower degree of diversification, hence reliance on oil. In turn,
fostering macroeconomic stability through appropriate economic and financial policies is a
prerequisite to the development of a viable and diverse non-oil sector.
12
See UNDP, 2011. The study shows that East Asian economies lost 18 percent of export revenue in 2009, while Middle East and
African economies, which exhibit a higher export concentration ratio, lost about 30 percent of export revenue. This loss in export
revenue also translated in growth performance with growth in South Asia declining by 1.4 percentage points while growth in Africa
fell on average by 3.4 percentage points. Growth in Arab oil-exporting Arab countries fell by 5.7 percentage points during in 2009.
DZA
KWT
OMN
QAT
SAU
UAE
YEM
0
2
4
6
8
10
12
-2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5
Standard Devation in GDP Growth 2005-14
(percentage points of GDP)
Economic Complexity
Output Volatility and Economic Complexity, 2014
Hydrocarbon exports <25% of total
Hydrocarbon exports >25% of total
Sources: Observatory of Economic Complexity; WEO and IMF staff estimates.
DZA
KWT
OMN
QAT
SAU
UAE
YEM
0
1
2
3
4
5
6
7
8
9
10
-2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5
Standard Deviation in Revenue 2005-14
(percentage points of GDP)
Economic Complexity
Government Revenue Volatility and Economic Complexity, 2014
Hydrocarbon exports <25% of total
Hydrocarbon exports >25% of total
Sources: WEO and IMF staff estimates.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 19
0
20
40
60
80
100
120
140
160
180
200
220
2015 fiscal breakeven price
Sources: National authorities; and IMF staff calculations.
2015
oil price
269 314
Fiscal Breakeven Oil Prices, 2015
(U.S. dollars per barrel)
Sound fiscal policy and framework
14. Oil-exporting Arab economies face a number of competing fiscal objectives in both
the short and long term.
A challenge for fiscal policy stems from unpredictable oil prices fluctuations that can be very large
and sometimes persistent. As expenditure is normally stickier than revenue, most of the volatility
in oil revenue tends to translate into the fiscal
balance in the short term, complicating the
conduct of fiscal policy. An illustrative
indicator of this issue is the fiscal break-even
price for oil-exporting countries, i.e., the level
of oil prices below which budget deficits
occur absent a reduction in expenditure.
13
In
2015, none of the oil-exporting Arab
countries is estimated to have had a fiscal
break-even price below the actual oil price.
Another challenge for policymakers stems
from the exhaustibility of oil reserves and the necessity to the meet the needs of current as well as
future generations. Governments typically face pressures to distribute a large share of oil
revenues to the population in the form of current spending (wages, subsidies). However,
balancing these short-term exigencies against factors supporting intergenerational equity—i.e.
higher quality spending in health, education, and investment as well as sufficient accumulation
of assets to permit sustaining per-capita spending levels even after oil reserves run out—is
needed to lay a sound foundation for future growth. In this regard, fiscal decisions on oil
revenues allocate wealth across generations.
The decision on how much to save and how much to spend of current oil revenue is crucial in
addressing these challenges. The trade off is between spending oil revenues now to address the
needs of the current generation and investing them to build the future of next generations,
while safeguarding long-term fiscal sustainability. When appropriate, determining the amount of
savings should go beyond intergenerational issues and consider the potential volatility of prices
and the need to create buffers to guard against it. Indeed, countries that scaled up spending at a
gradual pace, and those that have stabilization buffers are better prepared to manage sharp falls
in prices.
14
13
The fiscal break-even price is also sensitive to the level of production and to the level of exchange rate.
14
See IMF Fiscal Monitor, October 2015.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
20 INTERNATIONAL MONETARY FUND
15. The current low oil prices exacerbate the challenges, calling for fiscal consolidation
that should be as growth friendly as possible. The immediate concern of most oil-exporting Arab
countries is the size of the fiscal deficits and their
impact on debt sustainability. In this context, it is
important to focus on preserving fiscal space for
growth-enhancing spending while maintaining
fiscal sustainability. Increasing non-oil revenue,
notably through a broadening of the tax base
should be an important part of the strategy.
15
Expenditure restraint and the composition of
spending are also important. High quality
investment in infrastructure and human capital is
essential to bolster the productive capacity of the
economy and support economic diversification.
However, oil-exporting Arab economies have often
responded to distribution-related pressures by
raising current spending while curtailing investment
during downtimes. Lower investment may translate
into lower potential growth while the focus on
current spending (e.g., wages and subsidies) to
support consumption may contribute to reducing
the competitiveness of the private non-oil sector,
for example by raising reservation wages as further
discussed below.
16
As oil prices are expected to
remain low for a relatively long period and some
oil-exporting Arab economies still have significant
deficiencies in areas such as infrastructure,
education and health, fiscal consolidation needs to
be implemented carefully to preserve investment in
these areas.
17
Raising the efficiency and the quality
of spending, in particular investment, would help
smooth the impact of fiscal adjustment.
15
Initiatives in that direction are receiving increasing attention in some oil exporting Arab countries today. For
example, GCC countries are considering adopting a VAT, Kuwait is considering the introduction of a profit tax; Saudi
Arabia is considering increases in excises.
16
Many oil exporting Arab countries have already started to reform energy pricing. For example, UAE has
implemented energy pricing reforms by adjusting fuel prices and increasing electricity tariffs; Algeria, Bahrain, Oman,
Qatar, and Saudi Arabia have recently implemented substantial increases in energy prices; Kuwait has raised the
prices for kerosene and diesel and further energy price reforms are under consideration.
17
Sturm et al, 2009.
Bahrain 20.4
Bahrain 24.6
Kuwait 27.0
Kuwait 31.1
Oman 17.6
Oman 22.8
Saudi Arabia 27.7
Saudi Arabia 22.8
Algeria 18.0
Algeria 18.0
UAE 8.7
UAE 10.6
2010 2013
Bahrain 6.5
Bahrain 10.2
Oman 32.2
Oman 63.7
Saudi Arabia 20.7
Saudi Arabia 18.9
Algeria 15.7
Algeria 17.4
Kuwait 66.1
Kuwait 67.1
UAE 31.5
UAE 34.4
2010 2013
Arab Oil Exporters:
Selected Spending Categories,
2010-13
(Percent of non-oil GDP)
Wages and Social Benefits 1/
Other Current
Sources: WEO and IMF staff calculations.
1/ Kuwait excluding social benefits.
Bahrain 10.1
Bahrain 5.2
Oman 25.2
Oman 24.8
Saudi Arabia 20.0
Saudi Arabia 27.1
Algeria 23.1
Algeria 16.2
Kuwait 13.9
Kuwait 11.4
UAE 6.6
UAE 3.8
2010 2013
Investment
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 21
16. A robust fiscal framework is needed to navigate short and long-term considerations.
As fiscal authorities seek to allocate resources to maximize short- and long-term growth, a strong
fiscal framework can help ensure that
appropriate buffers are built to manage oil
price shocks, mitigating the risk of
overspending or lowering the quality of
spending in good times and overconsolidating
when oil prices fall (a real risk in the current
situation). A strong fiscal framework would
also support long-term sustainability and
intergenerational equity goals. Such a
framework needs to rely on long-term fiscal
anchors and may include a fiscal rule, for
instance based on non-oil deficit that is
consistent with the permanent income hypothesis. In the current environment, a fiscal rule could
help lock in the needed adjustment after it has been achieved. A stronger fiscal framework can be
supported by dedicated oil funds, the use of which should be governed by clear and transparent
rules and fully integrated with the budget. While the appropriate rule and the sequence of fiscal
reforms will vary across countries, oil-exporting Arab economies should continue to strengthen their
fiscal framework to help better align desirable and projected policies. Some countries have made
headways in that direction. Qatar for instance established a 10-year cap on public investments and
has prepared a draft medium-term fiscal framework and showed expenditure restraint even before
oil prices fell. Even countries with large proven reserves and a budgetary surplus might need
additional efforts in that direction to promote greater intergenerational equity.
Effective liquidity management
17. Domestic liquidity needs to be shielded from oil revenue fluctuations. Oil revenue
volatility poses particular challenges for the implementation of monetary policy and to financial
stability.
Many oil-exporting Arab economies, until recently, faced excess liquidity. This weakened
monetary policy transmission channels and increased risks of credit booms and inflation
volatility.
The recent decline in oil prices has contributed
to a drying up of excess liquidity in many oil-
exporting Arab economies (e.g., Algeria, the
GCC) and a concern is whether liquidity might
become too tight in some countries. Oil price
downturns are typically associated with large
drawdowns in government deposits in the
banking system—as the government attempts
to sustain spending levels—which in turn
-30
-25
-20
-15
-10
-5
0
Bahrain Kuwait Oman Qatar Saudi
Arabia
UAE Algeria Iraq Libya
Gap between Projected Fiscal Balances and Desirable Policies
(Percentage points of non-oil GDP)
Current Policies
Optimistic Scenario
Source: IMF staff calculations
Note: Difference between the projected medium-term non-oil primary balance (NOPB) and the NOPB recommended by the
Permanent Income Hypothesis. The high-growth scenario assumes higher non-oil growth by 1 ppt annually.
Libya
Likely policies: -56
High growth: -50
GCC
Non-GCC MENA
-20
-10
0
10
20
30
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Average Growth in Arab Oil Exporters'
Credit to the Private Sector and Oil Price, 2001-14
Cyclical component of oil price (USD)
Change in credit-to-GDP ratio in following year (percent)
Sources: WEO and IMF staff estimates.
Note: Calculated as a simple average. Excludes Iraq, Libya, and Yemen.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
22 INTERNATIONAL MONETARY FUND
contributes to a sharp decline in money supply (as both net foreign assets and net domestic
claims decline). The commercial banking system could be exposed to a liquidity crunch as
deposits dry up, which could lead to a sharp surge in interest rates. Moreover, tight liquidity
conditions could also affect private sector credit growth further—particularly as government
borrowing from banking system picks up—exposing the financial system to additional pressure.
18. Effective liquidity management involves better calibrating liquidity for banks, which
can be supported by the use of a government savings vehicle that invests externally, such as a
sovereign-wealth fund. Effective liquidity management would help improve the interest rate
transmission channel of monetary policy. Enhancing liquidity forecasting and putting in place
measures to appropriately calibrate liquidity in banks, including facilities to respond to bank liquidity
needs and development of appropriate collateral, could help reactivate the interbank market where
it has been dormant and facilitate the implementation of an interest-rate based monetary policy
framework. Improving liquidity management and reducing interest rate distortions would also help
deepen the financial sector, thus allowing financial markets to effectively perform the critical
functions of price setting, asset valuation, arbitrage, capital raising, and risk management that are
needed to support economic diversification. Sovereign-wealth funds invested abroad are also
helpful tools to insulate domestic liquidity from large swings in oil revenue.
18
Supporting financial policies
19. Oil price shocks could amplify the buildup of vulnerabilities in the financial system
through macro-financial linkages. As noted, during oil price upturns deposits in the banking
system tend to increase on the back of stronger fiscal position and surpluses in oil-corporate sector,
which typically leads to excess liquidity. As liquidity becomes easy, households and corporates may
be encouraged to excessive investment financed by borrowing—particularly in real estate, which
could trigger rapid credit growth, balloon bank balance sheets, and create asset bubbles. In the
event of an oil price downturn, these developments could reverse rapidly, further amplifying strains
in the financial sector and the real economy.
20. Financial policies can help mitigate risks to the financial sector and support economic
diversification. Strong regulatory and supervisory frameworks are necessary to stem risks to the
financial sector. Moreover, macro-prudential measures could prove useful in shielding the economy
from financial shocks resulting from the buildup of vulnerabilities in the financial system.
Countercyclical macroprudential policies would help mitigate credit risk and liquidity risk to financial
stability generated by the feedback loops between oil price movements, bank balance sheets, and
asset prices. Specifically, policymakers could implement countercyclical capital and liquidity buffers
and dynamic loans provision in good times to increase the resilience of the financial system, and
18
Among oil-exporting Arab countries, Bahrain, Kuwait, Libya, Qatar, and the UAE have such sovereign wealth funds.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 23
reduce the procyclical feedback between asset prices and credit.
19
Portfolio and/or financial
diversification would help mitigate concentration risk, particularly in GCC.
A fairly valued real exchange rate
21. A fairly valued real effective exchange rate is essential to economic diversification.
Economies that are highly specialized in extractive industries could fail to develop thriving secondary
or tertiary sectors because of rampant Dutch disease (i.e., situations where the dominant sector in
the economy causes a currency real appreciation that reduces the incentive to invest in other export
sectors). Such currency overvaluation would exacerbate the distortions in the relative price of
tradable and non-tradable goods. This would amplify the inefficiency in the allocation of production
factors across sectors and dampen prospects of new sources of growth. Conversely, an undervalued
real effective exchange rate may lead to short-term gains, but such gains tend to be offset by long-
term drawbacks stemming from an inefficient allocation of resources as most of the gains might lie
in firms that are less competitive than foreign peers and only survive because they exploit distorted
relative prices.
20
B. Regulatory and Institutional Frameworks Conductive to Private Sector
Growth
This section discusses the regulatory and institutional preconditions for private sector growth, including
improving the business environment, reducing regulatory barriers to competition, fostering greater
trade integration, reforming labor markets and facilitating greater access to finance.
22. A business environment conducive to private sector growth is necessary for economic
diversification. The business environment plays a key role in promoting private sector development
and hence greater economic diversification. While the business climate in GCC countries remains
relatively favorable, other oil-exporting Arab countries (Algeria, Iraq, Libya, and Yemen) rank low in
the World Bank’s doing business indicators. Beyond this disparity, the region faces common
challenges to improve the business climate. These include increasing the efficiency of government
administration (e.g., by streamlining procedures, establishing e-government), improving the legal
framework for the conduct of business (e.g., to resolve insolvency, enforce contracts, protect
minority investors) and fostering greater access to credit (Figure 4). Government efforts should
address these issues to ensure that private enterprises operate in an efficient, transparent, and
streamlined environment.
19
See also “Oil Prices, Financial Stability, and the Use of Countercyclical Macroprudential Policies in GCC,” IMF, 2015
forthcoming.
20
Rodrick, 2008.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
24 INTERNATIONAL MONETARY FUND
23. Reducing regulatory barriers to competition would also benefit economic
diversification by raising productivity. Many sectors in oil-exporting Arab countries are
dominated by state ownership. This high concentration level is a potential source of inefficiency in
domestic markets and impedes the development of the private sector. Reviewing relevant
regulations to increase competition would provide firms with incentives to reallocate resources to
more productive industries and be better equipped to survive fierce market competition.
21
In this
regard, competition authorities and competition laws should be strengthened to open up markets
to private enterprises. For instance, in Kuwait, a review of the competition policy law and its
implementation and of policies related to barriers to entry could help increase competition.
24. Greater trade integration could support export diversification. Arab countries are fairly
integrated through labor mobility and infrastructure but, intra-regional trade flows remain low
(about 12 percent on average) and largely consists in trade in oil. The Pan-Arab Free Trade Area
(PAFTA, 1997) and the Unified Economic
Agreement between members of the Gulf
Cooperation Council (UEA-GCC, 1998) do not
appear to have significantly boosted intra-regional
trade. Non-tariff barriers, such as lengthy customs
clearance procedures and high number of
documents and signatures needed to process a
trade transaction, remain important barriers to
intra-Arab trade. Promoting deeper regional
integration among Arab countries would require
reducing these barriers, liberalizing trade services
and strengthening rules applicable to regional
21
IFC 2013: Jobs study.
0
5
10
15
20
25
Share of Exports Going to the MENAP Region
(Percent of total)
2000 2014
Sources: Direction of Trade Statistics (DOTS) and IMF staff estimates.
-10
-5
0
5
10
15
-5 0 5 10 15
Change in Doing Business Distance to Frontier, 2010
-13
Average Real GDP Growth, 2011-14
Doing Business Distance to Frontier and GDP Growth, 2010-14
Top quartile (change in DB DTF)
Bottom quartile (change in DB DTF)
Sources: World Bank Doing Business (2015); and IMF staff estimates.
Note: an unequal variances t-test finds that the sample means are different (p<0.01).
Average GDP growth
for top quartile (4.5)
Average GDP growth
for bottom quartile (2.6)
DZA
BHR
IRQ
KWT
LBY
OMN
QAT
SAU
UAE
YEM
25
35
45
55
65
75
85
95
5.25 6 6.75 7.5 8.25 9 9.75 10.5 11.25 12
DB Distance to Fronteir, 2010-14
(higher score = fewer barriers to business)
Log of GDP per Capita (in USD), 2010-14
Doing Business and GDP per Capita, 2014
Hydrocarbon exports <25% of total
Hydrocarbon exports >25% of total
Sources: World Bank Doing Business (2015); WEO.
Trend for hydrocarbon exporters
Trend for non-hydrocarbon exporters
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 25
0
10
20
30
40
50
60
70
80
90
Overall
Starting a Business
Dealing with
Construction Permits
Getting Electricity
Registering Property
Getting Credit
Protecting Minority
Investors
Paying Taxes
Trading Across Borders
Enforcing Contracts
Resolving Insolvency
Doing Business Distance to Frontier
Non-GCC MENA
(100 = no barriers to business)
Algeria Iraq Yemen
trade.
22
Owing to a number of factors including geographical proximity and relative homogeneity in
economic structures, GCC countries are more integrated than the rest of the region. Some countries,
such as Bahrain, have seen opportunities arising from ongoing regional business integration,
particularly with Saudi Arabia, Kuwait, and the UAE.
Figure 4. Most Problematic Factors for Doing Business in Arab Oil Exporters
Source: World Bank Doing Business Indicators, 2015.
22
Chauffour, 2012.
0
10
20
30
40
50
60
70
80
90
100
Overall
Starting a Business
Dealing with
Construction Permits
Getting Electricity
Registering Property
Getting Credit
Protecting Minority
Investors
Paying Taxes
Trading Across Borders
Enforcing Contracts
Resolving Insolvency
Doing Business Distance to Frontier
GCC
(100 = no barriers to business)
Bahrain Kuwait Oman
Qatar Saudi Arabia UAE
Factor:
Algeria
(2012)
Bahrain
(2011)
Kuwait
(2013)
Libya
Oman
(2011)
Qatar Saudi Arabia UAE Yemen
Inadequately educated workforce
Access to financing
Restrictive labor regulations
Inefficient government bureaucracy
Poor work ethic in national labor force
Inadequate supply of infrastructure
Corruption
Policy instability
Insufficient capacity to innovate
Inflation
Government instability/coups
Foreign currency regulations
Tax rates
Crime and theft
Tax regulations
Poor public health
1-3 most common responses
4-6 most common responses
7-9 most common responses
10-16 most common reponses
Source: World Economic Forum Executive Opinion Survey, 2014 or latest year available. From a list
of 16 factors, respondents are asked to select the five most problematic and rank them from 1
(most problematic) to 5.
Note: Grayed-out cells do not have data available.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
26 INTERNATIONAL MONETARY FUND
25. Reviewing labor regulations can also help foster greater private-sector led job
creation. Although labor markets are relatively flexible in most GCC countries, regulations are
considered restrictive in some areas as evidenced by the Executive Opinion Survey undertaken by
the World Economic Forum (Figure 4). In other countries (e.g., Algeria, Kuwait, Oman and, to a lesser
extent, Saudi Arabia) insufficient labor market
flexibility is seen as a hindrance.
23
Various
degrees of labor market reforms are underway
in a number of countries. For instance, Saudi
Arabia has been implementing labor market
reform to streamline regulations while seeking
to improve work conditions. Regulations on
female employment have been eased, with
more sectors being opened for their
employment. Oman is updating the labor law
governing Omani and foreign workers, by
amending issues related to labor dispute
resolution, working conditions in the private
sector, and working conditions for women. Other oil-exporting Arab economies would also benefit
from reforms in labor regulations aiming to increase labor force flexibility while fostering better
working conditions and introducing unemployment insurance schemes where they do not exist.
26. Inadequate access to finance is a key factor inhibiting private sector development.
Access to finance is an important condition for private sector growth. The oil-exporting Arab
countries have a relative low percentage of firms with credit lines or loans from financial institutions,
and only a small portion of bank lending goes to SMEs. For instance, while credit growth is strong in
these countries, bank lending to private
sector only accounts for 10-30 percent
of non-oil GDP in Algeria, Iraq, and
Yemen. Further efforts to reform
financial system, reduce directed
lending, and develop domestic security
markets will be important to support
the financing of the private sector.
Specific measures would vary across
countries. Algeria, for instance, needs to
foster the development of the local
debt market to diversify financing
options for the corporate sector. Iraq
could continue to lift the restrictions
placed on private banks in obtaining government business.
23
Global Competitiveness Report, 2014-15.
Algeria
Kuwait
Oman
Saudi Arabia
Bahrain
Qatar
UAE
2
3
4
5
6
Labor Market Efficiency
(1-7 scale, 7 = best)
Source: World Economic Forum, Global Competitiveness Index (2015).
0
20
40
60
80
100
120
140
160
180
200
Allocation of Domestic Credit to the Economy, 2014
(Percent of non-oil GDP)
Credit to private sector
Credit to public sector/SOEs
Credit to financial sector
Source: IMF staff estimates.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 27
27. Financial constraints tend to be more binding for SMEs. Insufficient financing is an
important bottleneck hindering SMEs’ ability to grow into larger firms. Weak credit information and
creditor rights and an insufficient collateral infrastructure have been identified as the main reasons
for banks’ reluctance to lend to SMEs.
24
Progress has been achieved in some countries. For example,
the UAE has reduced impediments for SME finance by issuing a new law on SMEs and establishing
financial infrastructure such as a credit bureau and credit registry. In Saudi Arabia, the establishment
of dedicated SME units in banks and of a national credit bureau aim to support increased SME
access to finance. In Algeria, increasing the coverage of the existing credit registry would help foster
greater access to finance for SMEs. However, further efforts to enhance SME access to credit are
needed. Governments could strengthen the financial infrastructure such as credit assessment tools
and creditors’ rights, to ease SMEs’ access to finance.
C. A Public Sector that Enables Private Sector Growth
Drawing on previous work done at the Fund in the context of the GCC, this section analyzes the
interplay between public and private sectors. It argues that the public sector should enable, and not
compete with, the private sector, to support economic diversification. In particular, public employment
and wage policies should not discourage private employment, while public spending should focus on
investing in human capital, social safety nets and infrastructure.
25
28. The public sector is a dominant player in oil-exporting Arab countries and a catalyst in
the allocation of production factors. The combination of funding from oil revenue and (in some
countries ) a statist development strategy has resulted in a very large role of the state and/or public
enterprises in the economy, including in areas where the private sector could easily provide the
necessary goods and services. The presence of these public enterprises makes it all the more difficult
to create a level playing field for the private sector.
As noted, the share of the public sector in total GDP
remains high in many oil-exporting Arab economies.
The expansion of the public sector also involves
large-size civil service with generous compensations.
Rapid growth in government spending has
contributed to the growth of low-value-added
sectors such as construction, trade and retail,
transport, and restaurants. Producing goods and
services to meet domestic consumption and
investment needs tends to be a reliable source of
income, funded by the recycling of oil revenues.
24
Rocha 2011.
25
This section draws extensively on “Economic diversification in the GCC, past, present and future” (Callen and al.,
SND/14/12).
16.3
26.3
33.1
41.3
43.2
45.4
61.8
62.4
65.2
70.6
0
20
40
60
80
100
Non-Government, Non-Oil GDP Share of Total GDP, 2014
(Percent)
Sources: WEO and IMF staff estimates.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
28 INTERNATIONAL MONETARY FUND
29. Public sector wage policies reduce the incentive for individuals to look for private
sector jobs or launch their own businesses. As work conditions and compensation in the civil
service are typically generous in oil-exporting Arab countries, workers see jobs in the public sector
as the most promising path out of unemployment and an opportunity to earn a high salary and
secure employment. Subsidies to households contribute to increasing the reservation wage for
workers, thus reducing labor participation. In this context, only the most competitive, profitable and
growing private firms, who can pay substantially better wages than the public sector, can attract
skilled workers. As a result, where labor is scarcer, e.g., in GCC countries, the labor market is
segmented, with public sector jobs attracting nationals through high wages, while the private sector
relies more on an elastic supply of low-skilled foreign labor. Indeed, nationals in the GCC fill over
70 percent of public sector jobs, while, on aggregate, about 88 percent of 5.4 million private sector
jobs created between 2000 and 2010 were filled by foreign workers (about 85 percent of them with
low skills).
30. Furthermore, the excessive attractiveness of public employment exacerbates the skills
mismatches for the private sector. Better employment opportunities in public sector also increase
incentives for future job seekers to invest in education and skills that are generally most demanded
by public service, exacerbating the gap between the supply of skills and the need of the private
sector. Moreover, the inadequacy of educated workforce is an important constraint for the
development of firms in the private sector among oil-exporting Arab countries, as reflected in
related surveys (Figure 4).
31. Therefore, instead of de facto competing with the private sector, the public sector
should focus on enabling private-sector led employment growth. Actions need to be taken on
several fronts:
Reducing the excesses of public employment. Fostering private sector development should be
supported by a progressive reduction in the size of the public workforce and public wage
moderation. The latter would help gradually rebalance the relative prices of labor in the public
and private sectors and ensure that public sector wages are better aligned to productivity. To
1.6
3.1
2.5
4.0
3.2
3.1
2.0
6.6
1.0
2.3
1.3
1.5
1.5
1.3
1.0
4.6
1.0
0.5
1.1
0.6
0.5
0.3
0.8
1.7
0
1
2
3
4
5
6
7
Algeria Bahrain
(2014)
Iraq Kuwait
(2014)
Oman Qatar Saudi
Arabia
(2013)
Yemen
(2007)
Public sector wages to non-oil GDP per capita
Public sector wages to GDP per capita
Average wages to GDP per capita
Sources: ILO Global Wage Report; MCD REO; authorities' data; and IMF staff estimates.
Note: Public wages were calculated by dividing general goverment wage expenditure by total public employees. Algeria and
Saudi Arabia estimates use central government spending on wages. Average wages are from ILO data and were calcuated using
same year GDP per capita (see chart to right for the estimate year).
Public Sector and Aggregate Wages to GDP per Capita
(Ratio based on total public employment; 2012 or latest available data)
$5,458
$10,520
$3,836
$26,872
$10,923
$30,911
$18,362
$1,714
0
5000
10000
15000
20000
25000
30000
Algeria Bahrain
(2010)
Iraq
(2007)
Kuwait
(2011)
Oman Qatar
(2013)
Saudi
Arabia
(2014)
Yemen
(2006)
Average wages
Sources: ILO Global Wage Report; WEO; authorities' data; and IMF staff estimates.
Average Annual Wages
(Inflation adjusted USD; 2012 or latest data)
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 29
support a reduction in the size of public employment, a civil service review can help identify
nonessential positions that should not be renewed when they become vacant.
Orienting education and vocational training toward the skills needed in the private sector. First,
public spending on education needs to be increased in some countries. Indicators of years of
schooling and enrollment rates also reveal a
comparatively low level of academic
achievement. The quality of education also
needs to be improved in most countries and
better tailored to the need of the private
sector. The approach requires coordinated
efforts among relevant stakeholders such as
the public sector, the private sector, and
youth associations.
26
The private sector
should engage in the design of curricula for
vocational and tertiary education.
Providing unemployment insurance. Rather than using the civil service as the employer of last
resort, governments should put in place unemployment insurance schemes that ensure that the
unemployed receive a minimum income while setting proper incentives to look for employment.
32. Moreover, the public sector can further deliver basic infrastructure while ensuring
competitive public procurement policies. There is significant evidence that strong and efficient
investment in infrastructure is important to economic growth and diversification.
27
In several oil-
exporting Arab countries, infrastructure bottlenecks have been identified among the constraints
holding back the private sector capital formation, along with insufficient access to credit.
Furthermore, reducing excessive monopoly rents in the non-tradable sector by increasing
competition and enhancing bidding procurement processes would also help boost the private
sector.
D. The Road to a More Diverse Economy
This section discusses specific strategies that policymakers could use to help grow new sectors in oil-
exporting Arab countries. Drawing from examples in other countries, it discusses experience in
advancing horizontal and vertical diversification. It also discusses the role foreign direct investment in
the non-oil sector could play in fostering more broad-based economic growth.
26
IFC 2013: Jobs study.
27
See IMF, 2016, “Investment and Gorwth in the Arab World: A scoping Note”
Algeria
Oman
Kuwait
Saudi Arabia
Bahrain
UAE
Qatar
2
3
4
5
6
Quality of Higher Education and Training
(1-7 scale, 7 = best)
Source: World Economic Forum, Global Competitiveness Index (2015).
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
30 INTERNATIONAL MONETARY FUND
33. Economic transformation in oil-exporting Arab economies will follow its own
pattern. Economic diversification in today’s advanced economies began by a sharp decline in the
share of agriculture in total output and employment while the manufacturing and service sectors
grew larger. In a later phase, deindustrialization occurred, during which labor moved from the
manufacturing sector into services. However, the global environment is very different today than it
was then, and the structure of oil-exporting Arab economies is significantly different to that of
advanced economies at the early stage of their structural transformation. Agriculture has neither had
the largest share of employment, nor the largest contribution to GDP. The services sectors tend to
be already the largest source of employment (e.g., in Algeria, Bahrain, Iraq, Libya, and Saudi Arabia)
and a substantial fraction of labor force in that sector is on government payroll. Large economies—
in terms of the size of the population—tend to be industries dominant (i.e., industries have the
largest share in GDP) while small economies are mixed. When the economy is industry dominant,
industries concentrate on oil, reflecting its dominance in the economy.
34. Some oil-exporting Arab economies have experienced a certain degree of
diversification in the last decades, but it has been uneven. Bahrain has diversified by developing
banking and financial services—particularly Islamic banking—and increased non-oil exports and
non-oil output. The UAE has built, for example, a
commercial ship repair sector. In most cases,
however, economic diversification has moved at
a slow pace. Labor productivity growth due to
reallocation of labor across sectors has been low
and most of the aggregate productivity gains
have come from within sector productivity
growth (oil sector or private sector). Countries
where the productivity gains were the lowest are,
with the exception of Yemen, those with the
largest share of foreign workers who on average
tend to be low-paid but also low-skills and low-
productivity workers.
35. Policies can be considered to support promising sectors, although caution is called for
in light of the risks associated with “picking winners.”
28
There can be a case for some form of
industrial policies when (i) dynamic economies of scale or knowledge spillovers affect a sector;
(ii) coordination failures prevent a sector from developing; or (iii) informational externalities also
prevent the development of a sector.
29
However, the international experience of the past 50 years
suggests that “picking winners” and supporting infant industries can be tricky, because excessive
government protection tends to lower incentives to seek productivity improvements and enhance
28
This paragraph borrows from “Fostering Export Diversification in Algeria” (A. Lahreche, Selected Issues Paper for
the 2014 Article IV Consultation).
29
Pack and Saggi, 2006.
LBY
5.59
IRQ
4.20
DZA
4.13
SAU
2.52
BHR
1.31
OMN
0.60
KWT
0.59
QAT
0.21
YEM
-1.01
UAE
-5.97
-6
-4
-2
0
2
4
6
8
10
Growth in Non-Oil Real GDP per Worker, 2004-14
(Bars represent the average of countries' annual growth 2004-14)
Sources: World Bank; WEO; and IMF staff estimates.
Note: Real GDP substituted for countries that do not report domestic oil production.
World Average (2.5)
World Median (2.2)
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 31
international competitiveness. Industrial policies should, therefore, be carefully focused on sectors
with clearly high export potential and strong integration into international value-added chains—
although identifying such sectors is complex and risky. These sectors should be supported by
policies that foster innovation and backward linkages;
30
technology spillovers can be useful in
supporting industrial development and export diversification. Other “soft” industrial policies,
consisting for instance, of increasing openness to FDI, or setting up industrial clusters and export
processing zones, can also be instrumental, as shown in the case of the Indian software industry.
Developing horizontal and vertical diversification strategies
36. Oil-exporting Arab countries are at the early stage of their economic diversification.
As illustrated in Figure 2, the Gini coefficient for the
distribution of their manufacturing sectors is high,
which suggests a low degree of economic
diversification. While empirical evidence
31
suggests
that manufacturing sector concentration and per-
capita income tend to be correlated, with
diversification rising steadily until a certain income
threshold whereupon activity starts to concentrate
again, oil-exporting Arab countries, though most
already high income economies, lie outside the
curve for other countries. This suggests that they
are less manufacturing-diversified than the average
country at the same per-capita income level. Their
high income mostly represents resource
endowments, not structural transformation that has
shifted the economy to a higher level of per-capita income.
37. Vertical diversification would focus on sectors where the countries have an immediate
comparative advantage. It might be very difficult to promote several sectors at the same time
against the pull towards non-traded sectors that result from high domestic demand fueled by oil-
revenue-funded public spending. Nevertheless the potential for vertical diversification is high in
most oil-exporting Arab countries. In Algeria for instance, hydrocarbon exports are mostly made of
crude oil and gas, with limited exports of refined products and hydrocarbon byproducts, suggesting
that the potential for vertical integration into higher value-added products in the mineral and
chemical industries is sizeable. However, while such strategy could succeed in generating new
sources of growth and employment, it would not help significantly reduce the dependence on oil
and therefore the vulnerability to a volatile and exhaustible source of revenue.
30
Backward linkages exist when the growth of an industry leads to the growth of the industries that supply it.
31
Imbs and Wacziarg, 2003.
Manufacturing Value-Added GINI
1
(1990-2011, observations at 3-year intervals)
Sources: UNIDO INDSTAT4 database; and IMF staff estimates.
1
See Appendix 2.
DZA 2010DZA 2010DZA 2010DZA 2010DZA 2010DZA 2010DZA 2010
KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010KWT 2010
OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010OMN 2010
QAT 2010QAT 2010QAT 2010QAT 2010QAT 2010QAT 2010QAT 2010QAT 2010QAT 2010QAT 2010QAT 2010QAT 2010
SAU 2007SAU 2007SAU 2007SAU 2007SAU 2007SAU 2007SAU 2007SAU 2007SAU 2007SAU 2007SAU 2007SAU 2007
.3 .4 .5 .6 .7 .8
Manufacturing value-added GINI
7 8 9 10 11
Log of non-oil GDP per capita
All countries
Arab oil-exporters (latest observation)
Lowess smoother on all country observations
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
32 INTERNATIONAL MONETARY FUND
38. Horizontal diversification strategies would consist of expanding activities beyond
those sectors, across businesses not necessarily related to each other, and specifically to oil.
Because of new technologies or economies of scale, firms may profit from synergies and
diversification. Horizontal diversification would also be affected by how governments choose to
spend oil revenues as discussed above. Spending that reduces production costs in new sectors and
raises their efficiency, would encourage the entry of investors with new capabilities and knowledge.
The potential for horizontal diversification is also sizable in many oil-exporting Arab countries. In
Algeria for instance, the agribusiness sector and tourism are two areas of likely large untapped
potential, where receipts fall way below those in neighboring countries.
Further integration in the global value added chain
39. Global value chains are an additional mechanism through which firms in oil-exporting
Arab countries could access the world market and technologies. There is scope to join networks
of supply chains and specialize at certain stages of the production of complex economic goods.
Many oil-exporting Arab economies still find themselves at the beginning of the process of
integrating into global value chains. With exports dominated by oil, the share of foreign value added
in exports remains significantly low. Moreover, the depth of integration in global value chains
and/or the speed at which oil exporting countries (with hydrocarbon exports greater than
25 percent of total exports) join networks of supply chains is relatively lower. Further integrating
global value-added chains would require deep exploitation of comparative advantage—including
geographic position and labor intensity—improvement in technological capacity, greater efficiency
in production, higher technical and managerial skills, and competitive wages.
0
10
20
30
40
50
60
70
80
90
100
Manufacturing Value Added by Sector, 2008
(Share of total)
Food and beverages
Coke, refined
petroleum products
Chemicals and
chemical products
Non-metallic mineral
products
Other
Sources: UNIDO INDSTAT 4 database; and IMF staff estimates.
DZA
BHR
IRQ
KWT
LBY
OMN
QAT
SAU
UAE
YEM
0
10
20
30
40
50
60
70
3.5 5.5 7.5 9.5 11.5
Share of Foreign Value Added in Countries' Exports (percent)
Log of Non-Oil GDP per Capita
Hydrocarbon exports >25% of total
Hydrocarbon exports <25% of total
Depth of Integration in Global Value Chains and Real Non-Oil GDP per Capita, 2012
Sources: EORA database; WEO; and IMF staff estimates.
Trend for
non-hydrocarbon
exporters
Trend for
hydrocarbon
exporters
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 33
Box 2. Morocco: Diversifying Away from Phosphate and Agriculture
For years, Morocco’s economy was highly depended on agriculture, phosphate, tourism, fishing and seafood.
The reliance on phosphate and derivatives exposed Morocco's economy to the fluctuations of international
prices of phosphates, while rains determined agriculture output. Both factors greatly influenced the economy’s
business cycle.
In 2008, the government launched a Plan Emergence, a diversification strategy to widen the production base,
increase export products, and improve the resilience of the economy to external shocks—including phosphate
prices shocks. Despite adverse international conditions in recent years, the government has sustained its efforts
to implement important reforms and safeguard macroeconomic stability. These efforts are now bearing fruit as
testified by the emergence of newly developed industries (automobile, aeronautics, and electronics), which as
of 2014 represented a greater part of Morocco’s exports (28 percent) than traditional sectors including textiles
(17 percent) and phosphate (19 percent).
The service sector also expanded and diversified rapidly in products and markets. Financial activities have
grown and diversified abroad, specifically in sub-Saharan Africa. Morocco also developed further its tourist
industry, leveraging on the country’s geography, culture, and history. Approximately 10 million tourists visit the
country per year, providing plenty of foreign exchange.
Industrial development strategies led to improvement in infrastructures and development of a new port and
free trade zone. Morocco’s integration in global trade is also deepening, allowing to diversify trading partners
and to better position Morocco in global value chains. For example, the share of exports to the euro area in
total exports declined from 69 percent to 56 percent between 2003 and 2013. Over the same period, exports to
Latin America grew from 3 percent to 7 percent of total Moroccan exports, helping the improvement of the
external position. The continued flow of FDI to new sectors is expected to support their expansion over the
medium term.
However, agriculture, which accounts for only 14 percent of the GDP, continues to employ about 45 percent of
the labor force. Moreover, unemployment remains relatively high, especially for the youth. Additional
strategies are required to further diversify Morocco’s economy and reallocate labor to high productive sectors.
Improvement in agricultural techniques and irrigation systems are being sought, while further reforms in
business climate, education and judiciary systems, would increase the competitiveness of the private sector.
-6 -4 -2 0 2 4 6 8 10
Phosphate and derivatives
Textile and leather
Agriculture and agro-industry
Others
Automobile, aeronautics, and electronics
Sources: National authorities; and IMF staff estimates.
Morocco Export Dynamics by Sector, 2010-14
(Change in share of total exports between 2010 and 2014)
0
10
20
30
40
50
60
Primary Secondary Tertiary
Morocco: Horizontal Diversification
(Share of GDP by sector)
1980 2013
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
34 INTERNATIONAL MONETARY FUND
Box 3. Pattern of Diversification of a Resources-Based Economy: Malaysia
Malaysia relied heavily on primary commodities at the early 1980s. Primary commodities accounted for
33 percent of GDP and 77 percent of exports in 1980, which posed considerable challenges to the economy,
specifically in terms of managing the volatility from commodity prices. Malaysia launched an economic
diversification strategy in the early 1980s aiming to increase higher value-added activities and reduce the over-
concentration in upstream commodities (tin ore and rubber).
The National Industrial Policy and the Industrial Master Plans were particularly instrumental and included a
series of policy measures that aggressively promoted the manufacturing sector. The Industrial Master Plan 1
(1986-95) laid the foundation of manufacturing industries and promoted the processing of natural resources
and the development of local technological capability. The Industrial Master Plan 2 (1996-2005) improved the
competitiveness of manufacturing, broadened its base through the strategies of cluster-based industrial
development, while expanding along the value chain to encompass higher value-added activities. The
Industrial Master Plan 3 (2006-20) aims at further broadening the scope of economic activity by including
services and featuring functional targets such as SMEs, research and development, technology, logistics,
marketing.. The success triggered by the Master Plans resulted in a rapid space of horizontal diversification of
the economy, with increasing share of the manufacturing and services sectors, and less reliance on commodity.
Malaysian economy also diversified vertically by moving into high technological activities, which reduced the
share of commodities in exports.
Manufacturing developed through resource-based industries, including petrochemicals, refined petroleum,
palm oil, rubber gloves, tires and prophylactics products. Value-added of resource-based industries increased
significantly, as well as their contribution to exports. The diversification into resource-based industries also
ensures a high share of manufactured exports to total exports.
Well-designed industrial policies and a careful focus on sectors with high export potential and increasingly
integration into international value-added chains reduced the over-concentration on primary commodities and
increased the degree of intensity of economic activity across various interconnected industries. The vertical
diversification in the resource-based (i) deepened structural linkages of the economy and improved the
production function; (ii) increased profitability of firms while ensuring higher wages (for private workers) and
higher tax revenue for the Government; (iii) raised productivity across the board including in agriculture; and
(iv) continues to preserve macro stability.
0
10
20
30
40
50
60
Primary Secondary Tertiary
Malaysia: Horizontal Diversification
(Share of GDP by sector)
1980 2012
Sources: National authorities; and IMF staff estimates.
0
10
20
30
40
50
60
70
80
90
Primary Commodities Resource-Based
Manufacturing
Electronics and Electrical
Subsector
Malaysia: Vertical Diversification
(Share of total exports)
1980 2012
Sources: Authorities’ data; and IMF staff estimates.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 35
Attracting FDI in non-oil sector
40. Attracting foreign direct investment (FDI) in non-oil sector would support a broad-
based economic growth. The oil and gas sector has been the largest beneficiary of FDI in most oil-
exporting Arab countries. In Oman for instance, around 50 percent of FDI is invested in the oil
sector. As manufacturing and service export bases remain limited in many of these countries,
specialization and entrances in a specific segment
of global production chain could also benefit from
FDI while improving export quality and
sophistication, and accelerating technology and
knowledge transfers, specifically in the form of
FDI.
32
Improving the climate for foreign investment
in non-oil industry may involve lowering entry
requirements, creating investment promotion
intermediaries, and streamlining tax structures. For
instance, some countries impose a requirement of a
majority domestic ownership that is a significant deterrent to FDI and should be eliminated or at
least limited to strategic sectors.
CONCLUSION
41. Oil-exporting Arab countries face three-pronged challenges: job-creation,
macroeconomic volatility from oil prices and the depletion of oil resources. The oil sector
generates few jobs directly and the government sector tends to be the largest employer and offers
better compensation than the private sector. Over-reliance on oil exposes revenue and output to
fluctuations in oil prices, exacerbating macroeconomic volatility. Oil is also an exhaustible resource
and countries need to develop adequate non-oil sectors before their oil reserves are depleted.
42. To achieve economic diversification, oil-exporting Arab countries should continue to
strengthen macro-economic stability and improve regulatory and institutional frameworks.
These preconditions to economic diversification will make markets more flexible and competitive to
spur the innovation for goods, services, and job creation.
43. Policies and strategies to create dynamic new tradable sectors are needed to
accelerate economic diversification. Transitioning to a diversified economy with robust and
nimble tradable sectors requires additional policies and strategies to develop local technological
capability, promote the processing of natural resources, improve the competitiveness of non-oil
exports and broaden the export base through integration into global value chains to encompass
higher value-added activities.
32
IMF 2015: African Department Regional Economic Outlook.
Arab Oil Exporters' Cumulative FDI Flows
by Sector, 2003–May 2015
(Billions of USD)
Sources: Arab Investment and Export Credit Guarantee Corporation, 2015; and IMF staff calculations.
200.6
147.7
76.3
50.0
46.9
212.6
0
50
100
150
200
250
Petroleum Real estate Chemicals Tourism Minerals Other
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
36 INTERNATIONAL MONETARY FUND
44. Notwithstanding these key elements, economic diversification will not be successful
without security. Some countries (e.g., Iraq, Libya, and Yemen) are affected by wars that severely
disrupt economic activity and weaken investor confidence. Restoring stability and security should be
a first order priority to economic diversification.
45. Policies to support economic diversification should be tailored to country specific
circumstances. Oil-exporting Arab countries are different in many dimensions, and the choice of
policies to further advance economic diversification in these countries should take into account
country heterogeneity as well as capacity. The recent decline in oil prices has put strains on
governments’ resources thereby making the context of economic diversification in oil-exporting
Arab countries difficult but also more urgent. The labor force is young and growing and
unemployment, specifically for the youth and women, remains high in many countries. Policymakers
will need to move simultaneously to safeguard fiscal sustainability while pressing forward to
facilitate economic diversification.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 37
Appendix. Technical Notes
Estimate of government GDP (Figure 1)
The gross value-added (GVA) of an industry is measured as its total sales minus the cost of its
intermediate inputs, while the GDP of an industry equals its GVA plus taxes on products minus
subsidies on products.
Schematically, GVA is also equivalent to the sum of expenses (wages & salaries, dividends, and
depreciation), profits, and (indirect) taxes—minus net subsidies.
As public administration services are not marketed, the government sector does not generate
measurable sales. Consequently, the value added of public goods cannot be accurately determined.
Since governments do not pay taxes or dividends, generate profits or receive subsidies, only wages
and depreciation determine the gross value-added government services. For Arab oil-exporters,
data on the depreciation of government assets are not available; thus this paper uses government
wages as the best available proxy for determining government value-added.
Arab oil exporters manufacturing value-added GINI (Figure 2)
The chart on “Arab Oil Exporters Manufacturing Value-Added GINI” (page 32) reproduces the
analysis in Imbs and Wacziarg (2003) using more recent data from the United Nations Industrial
Development Organization Industry (UNIDO) Statistics database. The data cover the period 1990-
2011 and include 137 economies. Manufacturing is broken down into 23 subsectors in the ISIC-3
classification; the size of each sub-sectors being measured by its value-added. The Gini coefficient is
computed to assess the inequality of sectoral shares; the more equal the distribution of sector
shares, the lower the gini and the more diversified the economy. Specifically, the Gini coefficient is
calculated for each country and every year with exception of cases where a third of the sectoral data
are missing.
The analysis by Imbs and Wacziarg (2003) is based on the proposition that countries initially
diversify, on the back of dynamic evolution of relative productivity and declining transportation
costs, until they reach a point when the forces of concentration dominate—arising for example from
the pace of decline in transportation costs exceeding that for technological gap improvement.
Their hypothesis is generally supported by observed trends in industry data. Their result provides a
“U-shaped pattern” for the Gini coefficient over the income scale, indicating that countries tend to
diversify their industrial base as they move up the income scale, but at a certain point, this trend
starts to reverse—as income increases and inequality between industrial sectors increases. They
obtain this finding using Gini coefficient computed for value-added and also employment of the
subsectors in the ISIC-3 classification.
Staff’s analysis, using recent data, suggests increasing diversification for the average country as its
moves up the income scale and points to some reversal but not a very strong “U-shaped pattern”.
However, oil-exporting Arab economies tend to lie outside the curve (by more than two standard
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
38 INTERNATIONAL MONETARY FUND
deviation) as their income per capita is relatively high but their degree of economic diversification,
as indicated by the Gini coefficient, is low. In addition, while the Imbs and Wacziarg (2003)
hypothesis would assume that this reflects reversal, this is not the case for oil-exporting Arab
economies. One reason could be that the Imbs and Wacziarg (2003) hypothesis assumes a
traditional pattern of development, in which countries typically moved from agriculture to
manufacturing and then services. However, for resource-rich economies (e.g., oil-exporting Arab
countries) the high income levels may reflect natural endowments not necessarily structural
transformation that has shifted their economy to high level of income.
ECONOMIC DIVERSIFICATION IN OIL-EXPORTING ARAB COUNTRIES
INTERNATIONAL MONETARY FUND 39
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