A Dangerous Oil Habit

Despite rising crude prices, the gulf states have to push reforms--now

The annual get-together of the U.S.-Saudi Business Council at Washington's Mayflower Hotel in early October could not have occurred at a better time. Crude-oil prices are at levels not seen since Saddam Hussein's armies stormed into Kuwait six years ago. That means Saudi Arabia, the world's largest oil exporter, could pocket at least $45 billion this year from crude sales---a 10% hike over 1995. Top executives from such companies as Mobil, Citicorp, and Philip Morris listened to Saudi officials talk about business opportunities in the kingdom. The message: With Saudi Arabia emerging from a half-decade of hard times, now is the time to invest.

Leave it to often outspoken Treasury Under Secretary Lawrence H. Summers to puncture that bubble. No matter that higher oil prices helped Saudi Arabia to its first balanced budget since 1981. The country, says Summers, needs "to put its fiscal house in order." To do so, the Saudis must push through changes--from privatization to reforming a cradle-to-grave welfare system--that would spur the private sector and lay the foundation for long-term growth. "Summers was describing action that everyone knows has to be taken," says an attendee. "But the real question is whether the Al-Sauds will do it. Will the ruling family open up the system before it's too late?"

That question is being asked, as well, about the other five pro-Western oil states of the Persian Gulf--Kuwait, Qatar, Bahrain, the United Arab Emirates (UAE), and Oman. In all those countries and Saudi Arabia, loosely organized into the Saudi-dominated Gulf Cooperation Council, challenges to the well-entrenched system of hereditary family rule are mounting, inflamed in part by sky-high unemployment (table). Market-opening reforms may not address directly these political grievances but would serve to boost confidence and create jobs.

The irony: Today's sizzling oil market could ease the pressure on gulf rulers to enact these reforms. Since January alone, the price of a barrel of Brent crude has jumped some 50%, to $25.40, giving the gulf states as a whole $11 billion in extra revenue this year. Much of that is going into rebuilding cash reserves depleted by the gulf war or to paying long-overdue bills to contractors. "The windfall of higher oil prices is...being used to put off the inevitable," says David Rehfuss, a former State Dept. Middle East expert and now a senior associate at C&O Resource Inc. in Washington.

"WISHFUL THINKING." Signs abound that change is needed--and fast. Car bombs in Saudi Arabia hit U.S. military targets hard, an indication that homegrown discontent is reaching dangerous levels. In Qatar, Sheikh Hamad overthrew his father, Sheikh Khalifa, in a palace coup in June, 1995.

The most serious wake-up call comes from the island state of Bahrain---just across a narrow causeway from Saudi Arabia's largest oil fields and key oil installations. Since last year, frustration stemming from lack of jobs and the Al-Khalifah family's grip on power has spawned violent protests. Hotels and businesses have been bombed and hundreds of protesters arrested.

"Unless things change pretty dramatically, Bahrain is what will happen to the other gulf states in the future," says Jassem Al-Saadoun, head of Kuwait's Alshall Economic Consultants Ltd. "Unfortunately, there's wishful thinking everywhere in the gulf that higher oil prices can solve everything."

One pressing issue is the widespread unemployment among the gulf states' baby boomers--the generation born amid the oil bounty of the early 1970s. This group now is severely straining the states' welfare systems. The problem is visible in crowds of idle youth hanging around downtown Manama, Bahrain's capital. Over 75% of the 370,000 Bahraini nationals are under age 25, a ratio mirrored throughout the gulf. Unemployment, according to local economists, is currently above 25%. In richer Saudi Arabia, things are hardly better: Ads in local papers offering one or two jobs draw thousands of replies.

Even in gulf states that don't have a cash-flow problem, unemployment is a threat. Finding Kuwaiti graduates jobs these days means putting them on the government payroll--where 93% of the local population is employed. But such hiring has its problems. In the UAE, university graduates have to wait 6 months to 2 years to land a government job.

The only real way to lay the foundation for long-term growth in the gulf states is to reduce government domination of the economy and get private businesses to start investing and hiring. "Only a vigorous, growing private sector can solve the problems in the gulf," says Gary Sick, senior research scholar at Columbia University and former Middle East adviser on the National Security Council. But achieving that requires tough political decisions--from reining in ruling family members who try to muscle in on business to putting more backbone into commercial codes.

KEEPING CONTROL. The rulers, uneasy about creating economic and political counterweights, are moving slowly on privatization. For instance, governments in Saudi Arabia, Oman, and Bahrain have sold shares in state-owned companies to raise revenue, but still hang on to control.

It will probably take another severe economic downturn to compel the governments to act. Saudi Arabia, for one, moved forcefully to rein in uncompetitive subsidies on gasoline and wheat production in early 1995 but only after the country was confronted with its worst cash crisis ever. At that time, the government basically stopped paying its bills and even held up paying civil service salaries.

Now with the oil money pouring in again, reform has come to a halt. None of a series of measures to reform the Saudi economy advocated by the International Monetary Fund last year--from introduction of sales taxes and excise duties to raising artificially low utility tariffs and gasoline prices--has been acted on. In neighboring Kuwait, the government is using higher revenues to undercut parliamentary opposition: "Service candidates," promising increased pork-barrel spending and services, took many of the 50 contested seats in the Oct. 7 elections.

The gulf has potentially more going for it than just about any other area of the developing world. Apart from abundant natural resources, it has world-class airports, ports, and telecommunications, thanks to heavy infrastructure spending since the 1970s. The UAE alone--about the size of Maine--sports six international airports. And gulf nationals hold roughly $300 billion in offshore assets. "With the right combination of economic and political security, that money can come home," says Kuwait's Al-Saadoun. But given the complacency that the new flood of oil dollars is engendering in gulf rulers, that might not happen soon.

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