Introduction:

Saudi Arabia (officially Kingdom of Saudi Arabia) is the largest Arab country of
the Middle East. The kingdom is commonly listed as the world's 14th largest state.The
central institution of the Saudi Arabian government is the Saudi monarchy. The Basic
Law of Government adopted in 1992 declared that Saudi Arabia is a monarchy ruled
by the sons and grandsons of the first king, Abd Al Aziz Al Saud. It also claims that
the Qur'an is the constitution of the country, which is governed on the basis of the
Sharia (Islamic Law).

Saudi Arabia has an oil-based economy with strong government controls over major
economic activities. It possesses about 20% of the world's proven petroleum reserves,
ranks as the largest exporter of petroleum, and plays a leading role in OPEC. The
petroleum sector accounts for roughly 80% of budget revenues, 45% of GDP, and
90% of export earnings.
Saudi Arabia is encouraging the growth of the private sector in order to diversify its
economy and to employ more Saudi nationals. Diversification efforts are focusing on
power generation, telecommunications, natural gas exploration, and petrochemical
sectors. Roughly 6.92million foreign workers play an important role in the Saudi
economy, particularly in the oil and service sectors, while Riyadh is struggling to
reduce unemployment among its own nationals. Saudi officials are particulary
focused on employing its large youth population, which generally lacks the education
and technical skills the private sector needs. Riyadh has substantially boosted
spending on job training and education, most recently with the opening of the King
Abdallah University of Science and Technology - Saudi Arabia's first co-educational
university.
As part of its effort to attract foreign investment, Saudi Arabia acceded to the WTO
in December 2005 after many years of negotiations.. Five years of high oil prices
during 2004-08 gave the Kingdom ample financial reserves to manage the impact of
the global financial crisis, but tight international credit, falling oil prices, and the
global economic slowdown reduced Saudi economic growth in 2009, prompting the
postponement of some economic development projects. Saudi authorities supported
the banking sector during the crisis by making direct capital injections into banks,
reducing rates, and publicly affirming the government's guarantee of bank deposits.

Saudi Arabia is one of only a few fast-growing countries in the world with a high per
capita income of $20,800 (2008). Saudi Arabia has begun six "economic cities" (e.g.
King Abdullah Economic City) which are planned to be completed by 2020. These six
new industrialized cities are intended to diversify the economy of Saudi Arabia, and
are expected to increase the per capita income. The King of Saudi Arabia has
announced that the per capita income is forecast, to rise from $20,300 in 2009 to
$33,500 in 2020. The cities will be spread around Saudi Arabia to promote
diversification for each region and their economy, and the cities are projected to
contribute $150 billion to the GDP.

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Macroeconomic Policies:
The Government plays an integral part in Saudi Arabia, it uses two instruments
namely, fiscal and monetary policy to take control of the macroeconomic objectives
which are listed below:

 Steady Inflation Rate

 Keeping Unemployment Low
 Managing the Balance of Payment
 Managing the Exchange Rate
 Ensure Economic Growth

Fiscal Policy:

It is the term given to decisions to vary taxation or government expenditure in order

to influence the economic activity. It can be expansionary or contractionary in nature,
however considering the recessionary period the Government should look for an
expansionary policy where it should decrease the rate of taxation and/or increase its
expenditure in order to boost the economy.

The Kingdom of Saudi Arabia has a very liberal tax system; there are few taxes
payable by an individual or a company and they are also at very low rates.

1. Zakat:
The Zakat (a form of tithe) is paid annually by Saudi individuals and companies
within the provisions of Islamic law as laid down by Royal Decree No. 17/2/28/8634
dated 29/6/1370 H. (1950). The Zakat is an annual flat rate of 2.5 percent of the
assessable amount.
2. Personal Income Tax:
For individual employees, both national and expatriate, there is no income tax in the
Kingdom.
Self-employed expatriates such as doctors, accountants, lawyers, etc. pay taxes on
their net annual income at the following rates:

Net Income (per year) Tax Rate (percent)

First 6,000 Exempted
From SR 6,001 - 10,000 5
From SR 10,001 - 20,000 10
From SR 20,001 - 30,000 20
Over SR 30,000 30

3. Tax on Business Income:

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 A company, under the tax regulations, means a company or partnership having
material gain as the basic objective. The taxable incomes of companies include:
* profits of a foreign company;
* shares of non-Saudi sleeping partners in the net profits of partnership companies.

Tax Rate
Net Income (per year)
(percent)
First SR100,000 25
From SR 100,001-500,000 35
From SR 500,001-1,000,000 40
Over SR 1,000,000 45

Income tax is charged at different rates for companies engaged in the production of
petroleum and hydrocarbons in the Kingdom.
However, companies formed under the provisions of the Foreign Capital Investments
Regulations with participation of Saudi capital of not less than 25 percent are
exempt for up to ten years from payment of income tax.

Now, if we look at the other aspect of the fiscal policy which is Government
spending, it can be seen that Saudi Arabia Government is very determined to invest
in the economy, and plans to invest $400bn on infrastructure in coming 5 years of
time period of which it intends to spend $70bn this year.
The effect of this Government spending can be shown using the aggregate
expenditure analysis, as shown in fig A, below:
Y 45

AE2= C+I+G +X-M

E2
Aggregate
Expenditure AE1= C+I+G+X-M

E1

X
0 Y1 Y2
Income
Fig A

Interpretation:

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If we look at the current expansionary policy of Saudi Arabia , we see that the country
has no tax on the individuals income provided if hes not self employed. This would
allow individuals to enjoy a high desposable income, as a result of which the
aggregate income spent by these individuals can be expected to be high.
In addition to this, the Government is also going to invest $70bn this year and has
started 6 economic cities, which will shift the aggregate expenditure curve upwards as
shown in the diagram, thus leading to a higher income level of Y2, at the new
equilibrium level of E2. This money invested into the economy will boost the
economy and will gradually lead to economic growth.

Monetary Policy:

It reflects the decisions made by the Government authorities to vary the quantity of
money in the economy. Government can pass an expansionary or contractionary
monetary policy by using the three tools available to it, firstly the discount rate of the
central bank ( SAMA ) this is the rate at which the the central bank lends money to
the commercial banks, secondly, by the reserve ratio of the commercial banks, and
lastly by issuing bonds. However, considering the state of the economy and the
recessionary period the country should pass on an expansionary monetary policy in
order to increase the national income and raise the aggregate demand.

However, for Saudi Arabia , it has kept its currency pegged to the US dollar at Sr3.75
since June 1986. In order to maintain stability in the exchange rate of the currency the
Saudi arabia government varies its interest rates in accordance with the Fed interest
rates. Recently it has reduced its discount rate to 0.25% in line with the near zero
rate in the US.
Therefore, it can be stated that Saudi Arabia doesn’t posses direct control over its
monetary policy, but the current discount rate would enable the commercial banks to
borrow at a cheap rate, and one could expect the cost of borrowing to be low as banks
are expected to lend more in 2010 considering the business optimism and the low
discount rate from the central banks.

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 ISLM Analysis:
Y LM1 LM2

Interest

E2 Fig B
I2
E1 E3
I1

IS 2

IS 1
X
0 Y1 Y2 Y3
Y

The figure B above shows the ISLM analysis of the expansionary fiscal and monetary
policy which is passed by the Saudi arabia Government. On the graph the y axis
represent the interest ( cost of borrowing) and x-axis represents the income.
The IS ( investment saving ) curve is downward sloping which shows the negative
relation between the interest rate and the income. This is because at high interest the
cost of borrowing increases which decreases investment which is an integral part of
the income.
The LM ( liquidity and money supply) is upward sloping showing positive relation
between the rate of interest and the money supply.
The economy is in a state of equilibrium at E1, at an interest rate of i1 and an income
level of y1.
Now, considering the effect of Saudi arabia expansionary fiscal policy where it plans
to invest $70bn into its infrastructure, this will make the IS curve shift outwards
leading a new equilibrium E2 at the higher rate of interest of i2 and increased income
level of y2. Here we see that the higher income level of y2 was achieved at the cost of
higher interest rate of i2.
However, this year the expansionary monetary policy which is in line with the US
monetary policy , intends to keep the discount rate as low as 0.25% which is almost
near zero figure. This will ensure the supply of money into the economy by the
commercial banks as it would be easier for them to borrow from the central bank at
such a low rate.
This increased lending will increase the money supply in the economy thus resulting
in an outward shift in the LM curve from LM1 to LM2, also resulting in a new
equilibrium level at E3 , at a raised income level of y3 at the same interest rate of i1.

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 Unemployment & Inflation:

Unemployed labor force accounts for the people who are able and willing to work but
cannot get a job. . The non labour force includes those who are not looking for work,
those who are institutionalised and those serving in the military. Unemployment is
one of the major concerns for the Government as it helps them to get votes and enjoy
a sound political status. Although Saudi Arabia practices a monarch system, it tries to
keep the unemployment low as it is one of the major macroeconomic objectives of the
Government:
* The table above displays the monthly average.

DOWNLOAD MORE DATA

Read more:

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2009 Figure obtained from a different source 11.8
2008 9.80
2007 11.00

The above diagram shows the unemployment rate per year experienced by Saudi
Arabia economy, if we calculate the average of the unemployment rate it comes out to
be 10.37% which is slightly above the average rate. Furthermore unemployment can
be classified into its types, as explained below:

Frictional Unemployment:
It consists of people with physical or mental problems who will sadly never be able to
take up employment. It also includes those who have left one job and are looking of
taking up another job. This is considered as a sign of a dynamic economy, and to
some extent this type of unemployment is desirable.
Solution:
As for the Saudi Arabia Government this type of unemployment can be minimised if
the information flow is made two way and more efficient so that the employers and
the employees know about the whole recruitment process.

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Structural unemployment:
It is the unemployment caused by the mismatch of skills. This exists primarily
because of three main reasons, firstly, a change of technology which results in skills
becoming outdated, secondly, change in the international economic environment,
thirdly, location mismatch which makes labour immobile, thus they fail to get the
jobs.
Solution:
The Saudi Arabia Government can go into a joint venture with the industries which
are affected by the improvement in the technology and help them with designing
training facilities in order to make their employees competitive.

Demand Deficient Unemployment:

It is the unemployment caused due to a lack of demand and is an unacceptable and
undesirable state for the economy to be in. This also comes with associated costs like
loss in potential GDP, social costs like high crime rates, deterioration in health,
demoralisation, increased poverty, etc.
Solution:
In Saudi Arabia it can be expected to be low as government intends to invest a lot in
the economy which eventually improves the living standards of masses in the
economy, and this will also ensure that the spare capacity of the economy is also
utilised.

Classical Unemployment:
This is the unemployment which results as a result of wage differentials, if the market
wage is higher than the real equilibrium wage, this situation leads to insider-outsider
problem. A situation where the insiders already employed, enjoy high standards of
living and hold the influence, such employees hold the power of negotiations and
prevent outsiders from getting the jobs. To the extent they are successful, the
unemployment tends to persist.
Solution:
Saudi Arabia is a country where there are trade unions, however, there scope of
operation is very limited and they are not allowed to practice collective bargaining
this prevents the insiders from getting the power to hold the outsiders from the jobs
and enjoy the high standard of living.

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 Inflation:

It is a rise in the general price level ( the average price of goods and services ) over a
period of time. It further has two special cases.
Firstly, a situation where the price of every single good or service is rising at the same
point in time is called pure inflation.
Secondly, a situation where rising prices escalate out of control, which is known as
hyperinflation.
The most well known measures of Inflation are the CPI which measures consumer
prices, and the GDP deflator, which measures inflation in the whole of the domestic
economy.
The graph below shows the inflation of Saudi Arabia over a period of time:

* The table above

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2010 4.15 4.56
2009 7.88 6.91 5.95 5.21 5.48 5.19 4.18 4.07 4.40 3.50 4.00 4.25
2008 6.99 8.67 9.60 10.45 10.36 10.63 11.08 10.91 10.35 10.90 9.50 8.98
2007 3.57 2.98 2.86 2.86 2.96 3.06 3.83 5.04 4.89 5.35 6.00 6.47

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 Demand Pull Inflation :
This is defined as a situation where the aggregate demand for the goods and services
is greater than that the economy can supply. This can be explained with the help of a
diagram as shown below in fig C :
AS
Price Y
Level
P3 E3

P2 E2
E1 AD3
P1
Fig C

AD2

AD1
X

GDP1 Potential Real Real GDP

GDP

The above diagram shows the AD-AS analysis of the Saudi Arabia economy,
aggregate demand has various components which can be split into:

Aggregate demand = Consumption + Investment + Government + ( X-M)

Country experiences demands pull inflation when the aggregate demand increases
faster than the aggregate supply. If we see in the diagram, initially the equilibrium
was at E1, at the price level of P1 as aggregate demand increases which in Saudi
Arabia’s case was due to the rising oil prices and the money which the government
was injecting into the economy for the development of the infrastructure, economic
zones and new industries. This resulted in an upward shift of the aggregate demand
curve from AD1-AD2 it is in this time period that the countries redundant resources
get utilise and companies start to compete for the limited resources, thus leading to a
rise in the general price level from P1 to P2. Any further, increase in the aggregate
demand results in an increase in the price level as indicated by AD3 at a price level of
P3, as resources can only be increased in the long term.
In addition to this the property owners and businesses also increased prices
considering everyone else was doing it in the economy, without any proper
justification for the increase in the prices, which further fuelled the inflation.

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Inflation-Unemployment Link:

The relation between the inflation and unemployment can be explained by using the
Phillips Curve. It suggests that we can trade off unemployment against inflation and
vice versa. The country can target a lower rate of unemployment knowing what the
cost of achieving it will be in terms of higher inflation or alternatively the (increased)
unemployment costs of achieving lower inflation.
The diagram below shows the relation between the two:
Y

%
n
atio Fig. D
Infl

PC

% Unemployment

The Phillips curve is downward sloping because of the negative relation between the
inflation and unemployment. The table below justifies this relationship for Saudi
Arabia economy:
Phillips Curve Relation Inflation Unemployment
Year 2007 4.15% 11%
Year 2008 9.86% 9.8%
Year 2009 5.08% 11.8%

The table shows that when inflation increased in 2008 by 5.71% unemployed fell by
1.2% , this is because when the prices increase in the economy it serves as an
incentive for the producer to produce more as high quantity of goods are supplied at a
higher price ( law of supply ) . As a result of which the producers hire both more
capital and labour leading to a fall in the unemployment rate. However, in 2009 we

10
see that the government ended up with an increase in the unemployment rate of 2% in
order to decrease the inflation rate by 4.78% from 9.86% to 5.08%.

Global Economy:
One of the outstanding features of the second half of the twentieth century has been
the emergence of a truly global economy. It is to be seen in the internationalisation of
business- the growth and development of multinational companies in manufacturing
and in banking and financial services. It is to be seen in the dramatic growth in the
international trade.
For Saudi Arabia since the discovery of oil in the early twentieth century it has a
profound effect on its economic well being. The country has the largest oil reserves in
the middle eastern continent, making it one of the integral member of the
Organization of the Petroleum Exporting Countries ( OPEC ). Based on the latest
date, Saudi Arabia accounts for the 35% of the total proved reserves in the Middle
Eastern Countries, followed by iraq 15.2% and iran at 18% in 2008. The country is
also the largest producer of oil, accounting for some 41.4% of total oil produced by
the Middle Eastern region.

The chart below shows the graphical version of the contribution of oil exported from
the Middle Eastern countries:

Although mining and quarrying sector which basically includes ( crude oil and natural
gas) is the single largest sector of the Saudi Arabia economy, despite of the
Government effort to diversify the economy to domestic demand activities. In
adopting the Long Term Strategy (LTS) in its Eighth Development Plan (2004 –
2009), the government acknowledged that oil resources will eventually deplete, and

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necessary policy responses are thus required to ensure sustainability of economic
development in future.
The next chart shows the contribution of oil to the Government revenue:

Saudi Arabia derives its revenue mainly from oil, and it can be seen that in year 2007
it nearly touched 90%. The Governments fiscal strength is very dependent on the oil
revenues, and has proven to be very fragile if we consider the oil revenues of the
recent years, as shown in the table below:

Oil Revenue Budget

Year 2008 SR1.1trillion SR 176.6 billion surplus
Year 2009 SR 643billion SR 45 billion deficit

It can be seen that Saudi Arabia enjoyed a budget surplus of SR176b in the year 2008
due to rising oil prices, which crossed over $100 per barrel. In contrast to this the
revenue fell dramatically SR 505billion in the next year due to a fall in the oil prices.

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Composition of World Oil Trade:

The Organization of the Petroleum Exporting Countries (OPEC) was founded in

Baghdad, Iraq, with the signing of an agreement in September 1960 by five countries
namely Islamic Republic of Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. They
were to become the Founder Members of the Organization.
According to the latest statistics available it can be seen that Saudi Arabia contributes
25.8% of the worlds total reserves of oil, which is also 1/4th of the total oil of the
world.
The diagram below is the graphical representation of the data :

In 2008, it was also recorded that Saudi arabia economy experienced a value of
exports of $304.36billion where the value of export of petroleum stood at

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 $283.21billion, which is about 93.05% of the total value of exports. In addition to
this, the country also enjoys a market share of 25% of worlds oil reserves.

OPEC Flows of Crude and Refined Oil, 2008

(Thousand Barrels per Day)

North Asia and Latin Middle Total

Europe America Pacific America Africa East World
Middle East 2596 2568 12458 175 582 540 18919
IR IRAN 758 0 1801 0 153 0 2713
IRAQ 512 769 599 0 0 60 1940
KUWAIT 312 149 1945 2 39 0 2446
QATAR 0 0 801 0 0 0 801
SAUDI ARABIA 959 1634 4902 88 340 457 8380
UNITED ARAB EMIRATES 54 16 2409 85 51 23 2639
Africa 2757 2707 336 105 125 6 6036
ALGERIA 496 577 85 66 72 2 1298
ANGOLA 298 672 69 0 27 0 1065
NIGERIA 632 1396 85 0 0 0 2113
SP LIBYAN AJ 1331 62 97 40 27 4 1560
Asia/Far East 0 43 347 0 0 0 391
INDONESIA 0 43 347 0 0 0 391
Latin America 211 1392 138 1320 12 0 3073
ECUADOR 0 232 14 144 0 0 391
VENEZUELA 211 1160 123 1176 12 0 2682

The data above shows that Saudi Arabia had a total of 8380 thousand barrels per day of production
in year 2008, which is about 44.3% of the total production of oil as compared to other countries.
In addition to this, Saudi Arabias manufacturing industry also exports goods which on the other hand
make up only a fraction of the total production of the country. The graph below shows the graphical
representation of this distribution :

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 International Trade Theories:
International trade enables nations to specialize their production, enhance their
resource productivity, and acquire more goods and services. This can be achieved by
trading goods in which the country can produce efficiently by trading for goods and
services which it cannot produce efficiently.However, the complete answer to the
question “Why do countries trade?” hinges on three facts:

o The distribution of natural, human, and capital resources among nations is

uneven, natinos differ in their endowments of economic resources, as for
Saudi arabia it has 25% of the world’s oil reserves.
o Efficient production of various goods requires different technologies or
combinations of resources. For instance, Japan can produce efficiently a
variety of labor-intensive goods such as digital cameras, cd players , video
game players, other examples include luxury automobiles from Germany,
software from the united states, and watches from Switzerland.
o Products are differentiated as to quality and other non price attributes. A few
or many people may prefer certain imported goods to similar goods made
domestically.

Generally, the distribution of resources, technology, and product distinctiveness among

nations, however, is not forever fixed.When this distribution changes, the relative
efficiency and success with which nations produce and sell goods also changes, but if we
consider Saudi Arabia the it can be seen that the Government is also trying to diversify by
investing in the industrial sector and by building 6 economic cities to facilitate trade.

Oil Reserves Statistics

Proven Reserves (Oil Industry) Identified Recoverable
Reserves Reserves
Saudi Arabia 263.5 261.4 258.6 374.2
Saudi % of World 25.5 26.9 23.4 16.5

Black = billions of 42 gallon barrels

Red = % of World Oil Reserves

The table above shows, that Saudi Arabia has 258.6 of identified reserves which is
almost equal to its existing proven reserves. Furthermore, it also signifies that the
government has enough oil reserves that it could rely on them in future.

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Theory of Absolute Advantage:

Adam Smith came up with the theory of Absolute Advantage, the theory states, that in
the abscense of government interventionist policies, cost differences would explain
the movement of products across national boundaries. These differences reflected
natural and acquired advantages.
Smith Argued that free trade would allow that country to increase exports of the
products in which it had an absolute advantage, hence increasing the size of the
market.However, this theory has some unresolved difficulties to it . Firstly, it deals
only with the supply side of the market. Secondly, it theory holds true on the
assumption that if country A has an absolute advantage in the production of product
X then some other country B has an absolute advantage in the production of product
Y.
It further supposes that there is a demand for product Y in country A and a demand
for product X in country B. This double coincidence of demand is something which
is hard to find in the practical world therefore it may not be a very realistic theory, in
addition to this, unless these conditions are satisfied mutually advantageous trade
cannot take place.

Theory of Comparative Advantage:

David Ricardo introduced the concept of comparative advantage which remains the
keystone of analyses of international trade to this day.
It is based on a model with two countries, two products, and one factor of production,
labour. This theory demonstrates that even if one of the country has an absolute
advantage in producing both the products, and the second country has an absolute
disadvantage in both products, it may have a comparative relative advantage in the
production of one of the product. The argument can be justified using the opportunity
costs of production.
Lets say for the sake of argument we take two countries, A and B, two products, cloth
& plastic, and one factor of production, labor.

Units of output per hour of labour

Countries Cloth Plastic
A 14 25
B 11 19

Now clearly it can be seen that country A has an absolute advantage in producing
both the products cloth and plastic, and can produce efficiently.
However, when we consider the opportunity cost of production the picture changes.
Opportunity costs to both countries
Products A B

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 Cloth 1C=1.78P 1C=1.73P
Plastic 1P=0.56C 1P=0.58C
Suppose labour is fully employed in both countries and suppose further that there is
no trade and both countries want an additional unit of cloth. To gain more cloth they
both have to switch resources out of plastic production into cloth production.
For country A to acquire an additional unit of cloth requires a sacrifice of 1.78 units
of plastic, the opportunity cost of cloth. For country B, however, the sacrifice is only
1.73 units of plastic, which makes cloth relatively cheaper in country B. Whereas,
country B has an absolute disadvantage in both the products as seen earlier, but it
turns out that it enjoys a comparative advantage in cloth production.

Interpretation:

In the above scenario, both the countries should reallocate all resources to the
production of the product in which they have a comparative adcantage and exchange a
quantity of each product which they produce. Through trade both the countries can
consumre more of both products and obviously gains through trade.

However, as far as Saudi Arabia is concerned , oil makes up almost 90% of its
exports and is the major source of fiscal strength of the Government. It’s a natural god
gifted resource which only a fraction of the countries in the world possess.
Furthermore, oil is a necessity and every country needs to have it . Therefore, this
theory can help Saudi Arabia economy to trade with the countries where they have to
forgo less in order to attain more of other goods and services which they cannot
produce themselves. This would allow the residents of the country to enjoy a better
standard of living and they can make the most of what is available to them this way.

Heckscher-Ohlin Theory of Trade:

The H-O model is commonly referred to as the factor endowment model. According
to this model, there are two factors of production, capital and labour, which together
are used in the production of one or other of two goods. For ease of exposition, only
two countries are assumed by the model, although – the conclusion derived from the
theory are applicable to the a number of countries.

The central assumption of the model is that the two countries will exhibit
differences in relative factor endowments. As in, one country will have an
abundance of capital relative to labour – a capital rich country – while the other
country will have relatively larger supplies of labour relative to capital- ie it will be
labour-rich. These terms are strictly used in the application of the thoery.

That is to say, if Country A is labour rich then this means that it has a higher labour-
capital ratio than Country B. Necessarily in this case, Country B must be capital-rich
as it will have a higher capital-labour ratio than Country A.

The second assumption of the theory is that the goods produced can also be classified
as labour intensive ( meaning that relatively more labour is used to produce them) or
capital intensive ( meaning that relatively more capital is used to produce them ) .

17
 Furthermore, assuming that markets are perfectly competitive, and that technology is
identical between the two countries, we can conclude that the relative price of the
labour-intensive good will be lower in the labour-rich country where the labour is
relatively expensive. It should be clear that the price of the capital-intensive good
would be lower in the capital rich country. In this way we can see that the H-O model
ties comparative (cost) advantage in production completely to a country’s initial
factor endowment.

Interpretation:

Under the assumptions set out above, goods can be identified as capital or labour
intensive.If markets are competetive, this must mean that the country which has a
relative abundance of capital will be able to produce the capital intensive commodity
at a lower cost than te country in which capital is relatively scarce.. Consequently, the
capital rich country willl specialse in producing and exporting the capital-intensive
product. By precisely the same line of reasoning we can conclude that the labour rich
country will specialise in the production of the labour-intensive commodity.
As for Saudi Arabia, it exports oil, which was discovered in 1938 at a depth of
1,440m in the dammam oil fields. Since then the country has been exporting
petroleum and importing the capital and labour into the country.
The table below shows the value of the capital imported over a few years time
period:
Year 2001 2002 2003 2004 2005
Capital
$13,110,898,000 $14,107,756,000 $15,737,740,000 $19,294,972,000 $24,013,521,000
Expenditure

The table below shows the value of capital exported over the same time period :

Year 2001 2002 2003 2004 2005

Capital
Exported $955,365,000 $1,019,929,000 $1,180,450,000 $2,421,492,000 $2,451,041,000
In Value

If we just take year 2005 for comparison it can be seen that the value of Saudi Arabia
expenditure on the capital imported is just over $24billion however the value of
capital exported is only $2.4billion which is almost 10% of the amount spend on
capital imported. Thus it can be concluded that Saudi Arabia is constantly spending a
lot on importing capital into the country for development purposes.
According to another source, 23% of the population is made up of foreign nationals
living in Saudi Arabia, although the actual percentage is not measured in state censes.
There are over eight million migrants from countries all around the world (including
non-Muslims): Indian: 1.5 million, Pakistani: 1.1 million, Bangladeshi: 1.0 million,
Filipino: 950,000, Egyptian: 900,000, Yemeni: 800,000, Indonesian: 500,000, Sri
Lankan: 350,000, Sudanese: 250,000, Syrian: 100,000 and Turkish: 80,000. There are
around 100,000 Westerners in Saudi Arabia, most of whom live in compounds or
gated communities.

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 This shows that Saudi Arabia imports both labour and capital into the country, and is
constantly developing itself from the funds attained from oil exports.

International Trade Policies:

Internatinoal trade policies involves a range of policies adopted by a country in order
to influence the level of their exports and imports. The motives for a government
adopting this policy are varied but are often not based on the legitimate rationale of
increasing economic efficiency. As for Saudi Arabia it follows a trade policy which is
consistent with the main macroeconomic and microeconomic goals of the
Government.

Tariff and non-tariff barriers (NTBs):

Governments can adopt a range of trade policies which can be conveniently divided
between tariff and non-tariff barriers. The excise taxes on imported goods are called
tariffs. They can be in two forms, firstly, in the form of a lump sum tax measured
against the volume or weight of the product. Secondly, it can be based on a
percentage of the value of the imports, which is called Ad Valorem Tax.
A nontariff barrier is a licensing requirement that specifies unreasonable standards
pertaining to product quality and safety, or unnecessary bureaucrative red tape that is
used to restrict imports. Some countries require their importers to acquire licenses,
this way they can control the level of imports by restricting the licenses issued.
The following table shows the tariff rates of Saudi arabia on various imports :

Sr.# Items Description Tariff Rate

1 Cereals/ Coffee ( free ) Vegetables & Fruits ( selected items) 5%
100% or SR150 for
2 Tobacco
1000 cigarettes
3 Beverages (beer, wine and grape must are banned ) 5%
4 Plastic ( those with the gravity <0.94 had a rate of 8% ) 8% or 5%
5 Base Metal and Articles of base metals 5%
6 Vehicles (tractors have a high tariff of 12%) 5%
7 Electrical appliances 5%
8 Duty free commodities- pets, goats, animal for research, etc free

The table shows a variety of products which are imported into Saudi Arabia and the
tariff charged on them. It can be seen that necessities like cerial and coffee do not
have any tariff as they can be classified into necessities. However as for vegetables
are concerned the country does imply a tariff of 5% . As for tobacco, the tariff
charged is very high, which shows that government discourages the use of harmful
goods. As for the majority of the products imported for instance like, vehicles,
electrical appliances, beverages, base metals it can be seen that the Government of
Saudi Arabia charges a fixed tariff of 5%. Incase if a few types of plastics it charges a
tariff of 8% which is higher than the usual charge which could be because Saudi

19
Arabia itself is a manufacturer of plastic and 4% of its exports accounts for plastic
alone.
Objectives of Tariff and non-tariff barriers (NTBs):

o To protect a domestic industry –this is usually done to protect the infant

industries which refer to the new and growing industries in order to enable them to
stand up to the competetion of foreign companies. With the passage of time the new
company loses its disadvantages of being a late comer in to the business, and would
probably be enjoying economies of scale and become ready to compete with rival
firms.

o To control the level of consumption- this is to reduce the consumption of a

luxury or a bad good which is imported e.g cigarettes, which is the reason Saudi
Arabia has a tariff of 100% on tobacco.

o To generate revenue for the Government- the revenue obtained from the
trade taxes adds to the fiscal strenght of the Saudi Government, although they have
a low tariff of 5% on most of their imports. However, if we look at the fines
imposed on the violators of the trade laws, the fines range from SR 500 to SR5000
depending on the degree of violation. The total revenue obtained from the taxes
make up around 5.6% of the total GDP of the country as of year 2009.

o To protect employment level in the country- this is one of the most common
arguments for protectionism. It is done in order to reduce unemployment, because if
foreign competetion drives the domestic firms of the country out of business, it can
result if people losing job, which could lead to depression, escalating crime rate,etc.

o To improve the balance of payment – balance of payment is a record of all

the transactions of the country, if imports outstrip export exports then it means that
more money is leaving the country then entring it , resulting in a deficit of balance
of payment.

o To improve the terms of trade.- which is the rate at which units of one
product can be exchanged for another product.

20
Tariffs and their Effects:
Once again we turn to supply and demadn analysis- now to examine te economic
effects of protective tariffs. The curves Dd & Sd in the Fig E show domestic demand
and supply for a product in Saudi Arabia, in which it has a comparative disadvantage
lets say for the sake of argument the product is plastic.
Y Sd Sd + Q

E1 Fig E
Pd

Pt

Pw

Dd

X
a b c d
Q

Without world trade, the domestic price and output would be Pd & Q respectively(.as
for now disregard the curve Sd + Q).
Assume now that the domestic economoy is opened to world trade and another
country B who have a comparative adcantage in plastic, begins to sell in Saudi
Arabia. We assume that with free trade the domestic price cannot differ from the
world price, which here is Pw. At Pw domestic consumption is d and domestic
production is a. The horizontal distance between the domestic supply and demand
curves at Pw represents imports of ad.The rest of the analysis is split into its effects:

Direct Effects:
Lets say Saudi Arabia imposes a tariff of 8% on import of plastic. This would raise
the price of plastic from Pw to Pt, resulting in four effects:

Decline in Consumption:
An increase in the price from tariff from Pw to Pt results in a decline in demand.

Consumer Before Tariff After Tariff

Price Pw Pt
Quantity demanded d c
Net Loss High price of(Pt-Pw) x Reduced goods(d-c)
21
Increased Domestic Production:
An increase in price from Pw to Pt results in an increase in domestic supply, as more
is supplied at a higher price now.

Domestic Producer Before Tariff After Tariff

Price Pw Pt
Quantity Supplied a b
Net Gain (Pt-Pw) x (b-a)

Decline in Imports:
The producers of Country B which were exporting plastic to Saudi Arabia will be
hurt. Although the sales price of plastic is higher now by PwPt this amount accrues to
the Saudi Arabia Government as tax revenue. The revenue of Country B will decline
as their volume of exports will fall:

Foreign Producer Before Tariff After Tariff

Price Pw Pt
Quantity Supplied ad ac
Net Loss (Pw) x (d-c)

22
Tariff Revenues:
The orange rectangle represents the amount of revenue tariffs will yield to the Saudi
Arabia Government.

Before Tariff After Tariff

Price Pw Pt
Quantity Imported ad bc
Government Revenue 0 (Pt-Pw) x bc

The tariff revenue is a transfer of income from consumers to government and does not
represent any net change in the nations economic well being. The result is that
Government gains this portion of what consumers lose by paying more for plastic.

Indirect Effect:
Tariff allow residents to import as much as they want, but on the international scene,
it promotes inefficient producers and restricts world’s real output.

Economic impact of Quotas:

Import quota is a legal limit placed on the amount of some product that can be
imported in a given year. Quotas have the same economic impact as tariffs, with one
big difference: While tariffs generate revenue for the domestic government, a quota
transfers that revenue to foreign producers.
Suppose in Fig.E instead of imposing a tariff if Saudi Arabia goes for restricting the
number of imports equal to bc units. As a consequence of the quota, the supply of
plastic is Sd+Q in Saudi Arabia. This supply consists of the domestic supply plus the
fixed amount bc ( =Q) that importers will provide at each domestic price.
As for the price, it doesn’t extend below Pw as no other country would be willing to
supply at less than the world price. We can now compare the two different forms of
protectionism used as shown in the table below:

23
 Tariff Vs Quota
With Tariff With Quota Effect

Lose, as they get less (c) at a Lose, as they get less (c) at a
Consumers Same
higher price Pt higher price Pt

Domestic Gains, by producing more Gains, by producing more

Same
Producers (b) at a price of Pt (b) at a price of Pt

Government Saudi Arabia can generate Tariff +ve

No revenue is generated
Revenue revenue from tariff Point
Lose, as for them quantity Orange area of the diagram
Foreign Quota –ve
supplied decreases from d to shows the gain to foreign
producer Point
d, and their revenue falls producers

Therefore, it can be concluded that a country can be better off if it goes for imposing a
Tariff rather than a quota. As for now, Saudi Arabia hasn’t imposed any quota.

Non-tariff barriers (NTBs):

They include all the barriers to trade which are not in the form of Tariffs. They can be
classified in the following forms:

Quantitative & Similar Constraints:

o Export Constraints- Just like the import quotas but applied to the exports.
o Licensing- Requires both the importer and exporter to acquire a trade license, in
Saudi Arabia the registration fee is SR 500, which can be easily raised.
o Voluntary Export Restraints-limits set by the importing countries that are set by the
exporting country. It can be organized on multilateral or bilateral basis
o Exchange Controls- constraints on the receipt or payments in foreign currencies
most often in order to control capital movements but on occasions to control trade.
o Embargo- which is a complete ban for example wine, beer are completely
prohibited in Saudi Arabia because of strict Islamic ( Sharia ) Law.

Non-tariff Charges:

24
 o Antidumping penalties- this is when a charge is put on the imports when it is
maintained that the prices set by foreign firms do not accurately reflect the costs of
production.
o Deposits in Advance- this requires that a proportion of the contract price is
presented in advance of the exchange and payment of the goods or services.

Customs Administration:
o Administrative process- the process by which goods clear customs can be punitive
in terms of the time taken and leakages. This leads to increasing costs for the
foreign firms as the stock can remain in bonded warehouses for some time. As for
Saudi Arabia, if the import is done with the help of a local Saudi national, the
Government does facilitates, by providing 10 days of free storage space.
o Valuation Criteria- the application of pricing system on which to base tariffs which
is systematically different to the invoice price. If the customs value imports at a high
price this increases the duty for the importer thus resulting in goods becoming
uncompetitive in the domestic market. As for Saudi Arabia lets say if we take
vehicles the value is calculated after applying a method of depreciation on the price
of the vehicle when it was new, which can give the importers a good idea of how
much the car would cost afterwards, which keeps traders certain and makes trade
easy.

Technical Barriers to Trade:

o Safety and industrial Regulations
o Health and Sanitary Standards
o Packaging/labelling regulations.
o Advertising and media regulations.

Such NTBs can be difficult to identify and consequently to quantify. To the extent
that this is true the possibility of negotiated reductions is more problematic.
Sometimes domestic producers with influence aim for NTB despite of its negative
impact on national welfare as it facilitates their business in the long run.

Balance Of Payment:
A nation’s balance of payment is the sum of all the transactions that take place
between its residents and the residents of all foreign nations. Those transactions
include exports and imports of goods, import and export of services, tourist
expenditures, interest and dividends received or paid abroad, and purchases and sales
of financial or real assets abroad.
The statement shows all the payments a nation receives from foreign countries and all
the payments it makes to them.
A single balance of payments is divided into three components: the current account,
the capital account, and the official reserves amount.

Current Account:
This account comprises of the countries trade in currently produced goods and
services. Saudi Arabia exports are taken as a credit item into the account, they earn
and make available foreign exchange in the Saudi Arabia. The supply of foreign
currency is kept with the Saudi Arabia banks.

25
 In the same manner, the Saudi Arabia imports are taken in as a debit item as they
reduce the stock of foreign currencies in the Saudi Arabia. The out payment made to
the rest of the world against these imports decreases the foreign reserves for Saudi
Arabia.
The balance of trade for Saudi Arabia economy is the difference between its exports
and its imports of goods. If exports exceed imports, the result is a surplus on the
balance of goods, however, if imports outstrip the export its considered as a deficit.
The balance on goods and services is the difference between the Saudi Arabia exports
of goods and services and Saudi Arabia imports of goods and services. A trade
surplus is considered as a favourable state for the country, rather than a trade deficit.
The graph below shows the balance of trade for Saudi Arabia for the past few years:

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total
2008 137043.0 137043.0
2007 79818.8 79818.8

Saudi Arabia reported a balance of trade surplus equivalent to 137043.million of US$

in December of 2008. Saudi Arabia is the world's leading oil producer and exporter.
Oil accounts for more than 90% of the country's exports. Saudi Arabia mostly
imports machinery and equipment, foodstuffs, chemicals, motor vehicles and textiles.
Its main trading partners are: Japan, European Union, China and the United States.

It can be seen from the graph that in year 2007 Saudi Arabia balance of trade was
79819million US $ , which increased dramatically in year 2008 considering the rise
in the price of oil, resulting in an increase in the balance of trade up to 137043m US$,
which is a 72% increase from the previous year.

26
 Year Mar Jun Sep Dec Total
2008 132322.0 132322.0
2007 93392.4 93392.4

The current account shows a surplus of 132322m US$ for the year 2008, the current
account includes both balance of trade (visible goods) and balance on services. As the
balance of service wasn’t available one can still calculate the balance on services. By
subtracting the balance of trade from the current account balance of trade, which is
($137043m-$132322m = $4721m. This shows that the huge surplus from the trade of
goods which is a component of the current account was reduced by $ 4721m by the
heavy import on services over the same year.

Capital Account:
The second account with the overall balance of payments account is the capital
account, which summarises the purchase or sale of real or financial assets and the
corresponding flows of monetary payments that accompany them. For example, a
foreign firm may buy a real asset, say, an office in Saudi Arabia or say a Government
security. Both kinds of transaction involve the export of the ownership of Saudi
Arabia assets from the Saudi Arabia in return for in-payments of foreign currency.
Conversely, a Saudi firm may buy say a hotel chain in a foreign country or some of
the common stock of a foreign firm. Both transactions involve the import of the
ownership of the real or financial assets to the Saudi Arabia and are paid for by out-
payments of foreign currencies. These imports are designated Saudi purchases of
assets abroad, and they represent an outflow on the capital account.
However, the law guaranteed foreigners protection against Saudi nationalization of
particular industries and reduced the income tax on foreigners. The Capital Market
Law of 2003 created further opportunities, allowing for initial public offerings and
denationalizing some industries. In 2004 Saudi Arabia received about US$300
million in foreign direct investment. According to the Saudi Arabian General

27
Investment Authority (SAGIA), investment capital secured through investment
licenses increased 787 % in the first quarter of 2005 over the same quarter in 2004.
Despite these advances, foreign investors have been hesitant to participate in Saudi
ventures because of the long tradition of government interference in the marketplace,
bureaucratic nuisances, and concerns about instability and terrorism. Moreover, the
government continues to ban foreign investment in national defence or certain sectors
with religious significance such as health and pilgrimage services.

Official Reserves Account:

The third account in the official balance of payment is the official reserves account.
The central bank of Saudi Arabia hold quantities of foreign currencies called official
reserves.
These reserves can be drawn on to make up any net deficit in the combined current
and capital accounts (the same way a person draws from his savings to pay for a
special purchase) .
As for Saudi Arabia if we look at the balance of trade which is the information
available it can be predicted that Saudi Arabia should have pretty sufficient foreign
currency reserves than it needed.
The three components of the balance of payments ( the current account, the capital
account, and the official reserves account) must together equal zero.

Exchange Rates:
It refers to the rate of one nation’s currency in terms of another nation’s currency. As
for Saudi Arabia, it maintains a fixed exchange rate regime, pegging the Saudi
currency (Riyal) to the U.S. dollar at $1=SR3.745. This makes trade between Saudi
Arabia and US easy as there is no uncertainty, however, the Saudi Arabian Monetary
Agency (SAMA) ability to employ a monetary policy is constrained due to its
commitment to the fixed exchange rate against dollar. Thus, changes in the Saudi
money supply and interest mirror the changes taking place in US money supply and
interest rates.

Forms of Exchange Rates:

The system of exchange rates used by a country allows it to rectify the imbalances in
its balance of payments deficits and surpluses. There are two pure types of exchange
rate systems:
Flexible-or Floating Exchange Rate System:

28
 This is where the demand and supply determines the exchange rates and in which no
government intervention occurs.
We can examine the rate at which KSA might be exchanged for British pounds. As
shown in fig. F below:
Y
Exchange Rate: S1
SR 5 = 1 pounds

Riyal depreciates
d (pound appreciates)
un
Po Fig. F
of 1
ce Riyal appreciates
pri (pound depreciates)
SR

D1

X
Quantity of Pound

The curves D1 and S1 show the demand and supply of pounds in the currency market.
The demand for pound curve is downward sloping because all British goods and
services will be cheaper to the KSA if pounds become less expensive to the KSA.
Thus, at lower KSA prices for pounds, the KSA can get more pounds and therefore
more British goods and services per riyal. To buy those cheaper British goods, KSA
consumers will increase the quantity of pounds they demand.
The supply of pounds curve is upward sloping because the British will purchase
more KSA goods when the riyal price of pounds rises ( that is when pound price of
riyal falls). When the British buy more KSA goods, they supply a greater quantity of
pounds to the foreign exchange market. In other words, they must exchange pounds
for riyals to purchase KSA goods. So, when the riyal price of pounds rises, the
quantity of pounds supplied goes up.

Interpretation:
An exchange rate determined by market forces can, and often does, change daily like
stock and bond prices.
Depreciation- when the riyal price of pounds rises, for example from SR5=1 to
SR7=1, the riyal has depreciated relative to the pound ( and pound has appreciated).
When a currency depreciates, more units of it (riyal) are needed to buy a single unit of
some other currency (pound).
Appreciation-when the riyal price of pound falls, say from SR5=1 to SR3=1 the riyal
has appreciated relative to the pound. When a currency appreciates, fewer units of it
(riyals) are needed to buy a single unit of some other currency (pounds).

29
 Three Basic Generalizations
Demand Increases Currency Appreciates Demand Decreases Currency Depreciates
Supply Increases Currency Depreciates Supply Decreases Currency Appreciates
If a nation’s currency appreciates some foreign currency depreciates relative to it.

Thus, depreciation of pounds means appreciation of riyal and vice versa.

Determinants of Exchange Rates:

o Change in taste – any change in consumer tastes or preferences for the products of a
foreign country may alter the demand for that nation’s currency and change its
exchange rate.
o Relative Income Changes- a nation’s currency is likely to depreciate if its growth of
national income is more rapid than that of other countries.
o Relative Interest Rates- changes in relative interest rates between two countries may
alter their exchange rate. People invest in the country where they have a better
return on their investment; this increases the demand for the currency, which
ultimately results in the appreciation of the currency.
o Speculation- currency speculators are people who buy and sell currencies with an
eye toward reselling or repurchasing them at a profit.

Fixed Exchange Rate System:

Saudi Arabia has a fixed exchange rate with United States, and the Government of
the two nations maintain SR3.75=$1.
The problem is that such a government agreement cannot keep from changing the
demand for and the supply of dollars. With the rate fixed, a shift in demand or supply
will threaten the fixed exchange rate system, and government must intervene to
ensure that the exchange rate is maintained. Usually there is a limit + or – 1% by
which the actual exchange rate may deviate from the peg.

Y
S1

c
$1 Exchange Rate:
of SR 3.82 = $1 pounds
ce
pri
SR Fig. G 30
Quantity of Dollar D1 X
 a
b
B.O.P deficit
Exchange Rate:
SR 3.75 = $1 pounds

D2

Now in the above Fig. G suppose the KSA demand for dollar increases from D1 to
D2 and a KSA payment deficit ab arises. Now, the new equilibrium exchange rate
(say SR 3.82 = $1) which is above the fixed exchange rate of (SR3.75=$1).
The imbalance created can be adjusted by altering the market demand or market
supply or both so that they will intersect at the SR3.75=$1. The Government has
several ways to do this. Such as:

Protectionism- the government can resort to ways of reducing imports by using a

tariff, a tax on foreign products. However, the feasibility of this option is however
extremely limited.
Firstly, countries have treaty obligations under the General Agreement on Tariffs and
Trade.
Secondly, any such action may result in retaliation so that while foreign currency
payments may fall through reduced imports, foreign currency earnings may also fall
through reduced exports. However, for KSA oil makes up 90% of its revenues, and is
a commodity which is a necessity, which leaves the Government with an advantage.

Contractionary Fiscal Policy- the imports of the country can be reduced if the
domestic demand is decreased, which can be achieved by increasing the taxes in order
to reduce the disposable income, and by reducing the government expenditure. This
policy deflates the economy.

Interest Rates- This policy can be expected to operate both on current and capital
account of the balance of payments. A high rate of interest, reduces the domestic
investment as cost of borrowing goes up, and also decreases the credit financed
consumer expenditure in the economy, thus reducing the demand of imports. Higher
interest rates may also discourage local investors in investing abroad.

Improved Domestic Goods- this is a long term solution, where the Government of
KSA should establish more industries in the country, help companies in research and

31
development projects, invest in country’s workforce in order to raise productivity and
quality of the domestically produced goods.

Bretton Woods System:

In 1944 major nations held an international conference produced a commitment to a
modified fixed exchange rate system called an adjustable-peg system or simply
Bretton Woods System. The system was designed to capture the advantages of gold
standard (fixed exchange rates) while avoiding its disadvantages (painful domestic
macroeconomic adjustments).
Furthermore, the conference created International Monetary Fund (IMF) to make
the new exchange rate system, feasible and workable. IMF still plays a basic role in
international finance, providing loans to developing countries, helping nations in
crisis, and nations making the transition from communism to capitalism.

Under the Bretton Woods System there were three main sources of the needed dollars:

Use of Official Reserves:

One way to maintain a fixed exchange rate is to manipulate the market through the
use of official reserves. Such manipulations are called currency interventions. By
selling part of its reserves of dollars, the KSA government could increase the supply
of dollar, shifting the supply curve S1 to the right so that it intersects D2 at b thereby
bringing the exchange rate back to SR3.75=$1.

Gold Sales:
The KSA Government might sell some of its gold to US for dollars. The proceeds
would then be offered in the exchange market to augment the supply of dollars.
According to the world official Gold holding, KSA has a Gold Reserve of 143. tonnes
which is quiet acute, primarily because of the reason that the economy exchange rate
is backed up by oil

IMF Borrowing:
The needed dollars might be borrowed from the IMF. Nations participating in the
Bretton Woods system were required to make contributions to the IMF based on the
size of their national income, population, and volume of trade. If necessary, the KSA
could borrow dollars on a short term basis from the IMF by supplying its own
currency as collateral.
As for Saudi Arabia, the country is one of the 186 member countries who have joined
IMF, the position of the country is strong as it is one of the major oil producing
country. However, the country backs plans to increasing emerging nations say in the
IMF by improving their voting capacity.

The Managed Float:

In Managed Floating exchange rates among major currencies are free to float to their
equilibrium market levels, but nations occasionally use currency interventions in the
foreign exchange market to stabilize the market exchange rates.
Normally, the major trading nations allow their exchange rates to float up or down to
equilibrium levels based on supply and demand in the foreign exchange market. The

32
changing environmental conditions among nations require continuing changes in
equilibrium exchange rates to avoid persistent payments deficits or surpluses.
But nations also recognize that certain trends in the movement of equilibrium
exchange rates may be at odds with national or international objectives. On occasions,
nations therefore intervene in the foreign exchange market by buying or selling
large amounts of specific currencies. This way, they can “manage” exchange rates by
influencing currency demand and supply. As for KSA apart from US it manages its
currency by Managed floating exchange rate system, and the table below shows the
exchange rate of the country with some countries:

Currencies Rates
US Dollar 3.75
Pound Sterling 6.630
Indian Rupee 0.145
Uae Dirham 1.02
Japanese Yen 28.88
Pakistani Rupee 0.152
Canadian dollar 3.349

The Saudi Arabia tries to keep the exchange rate movements into control, as it is one
of the main macro economic objectives of the Government, and at times, it also acts
like a tool to help achieve other macroeconomic objectives.

International Economic Integration:

International economic integration means full economic union among a group or
groups of countries. Frequently this is also called 'total' economic integration in

33
distinction of some other international arrangements involving closer economic
cooperation or some degree of integration such as free trade areas, customs unions,
and common markets. From Islamic point of view any arrangements are welcome as
long as it would lead to the establishment of closer-co-operation or stronger ties
among Muslims. The nature of these economic integration relationships usually
results in achieving synergy effects. Economists recognise four different main levels
of international economic integration, they are:

Free Trade Area:

These are trading agreements by which all barriers to trade are removed between the
participants but each partner has the freedom to negotiate independently with any
other non participating country as to the regulation of trade.
This agreement should lead to common prices for internally produced goods within
the area as any price differentials would be quickly dealt with by buyers and sellers
trading between the high and low price markets.
Problem: Is the arrangements one participating partner can make with a country
outside the agreement. It is also possible that a country may independently negotiate
favourable trade terms with a country from outside the agreement.

Customs Unions:
It can be considered as an extension to the free trade areas. It incorporates the idea of
a free trade area but with the addition of a common trade policy for all countries with
the custom union to all countries outside the union.
Merits: It eliminates the problems faced with the free trade area, in addition to this in
a state of union the countries can collectively bargain for better deals.
Demerits: The problem arises where the reluctance of countries to entering a customs
union rests with their opposition to sacrificing an area of their sovereignty.

Common Market:
This is a customs union plus the facility for the freedom of the factors of production,
namely labour and capital to move between countries. This enables the unrestricted
flow of labour and capital across national borders within the common market. In
reality the flow of capital is rarely restricted between the borders, but the ability of
workers to move is highly constrained.
Demerits: Centralisation of control fades away as we move up the economic ladder of
integration, the nation’s authority continues to erode and the trade off between the
economic returns and economic sovereignty widens.

Economic & Monetary Union:

The final step up the integration ladder occurs when the national monetary and fiscal
policies are united. Any influence that a country will have depends on their
representation in the executive, central bank or in the parliament that determines or
oversees the actions of the newly created state. This leads to a common currency and
a single central bank to control the monetary policy. Furthermore, it may often lead to
the centralisation of the responsibility and authority for decisions on taxation and
government expenditure.
However, it is difficult enough when evaluating the economic costs and benefits but
when the political and social repercussions are also brought into the equation then it is
very much more an act of faith than a rationally taken decision.

34
The Table below shows the SWOT Analysis of the Arab Countries:
Strengths

• Arab have strong historical, religious, cultural, and language affinities

• Common and unique values and moral standards
• There are capital, intellectual, labour and skills
• There is a great threat facing them
• Privatization and liberalization

Weaknesses

• Lack of trust and commitment

• Lack of a healthy investment environment and capital market
• Economic and political independence on Western Countries, e.g. USA
• Identity problem and crisis
• Conflicts between Arabs
• Tussle between 'the B's' - business and bureaucracy
• Lack of statistics and dependable demographic studies
• Lack of experimental science and technology
• Existing trade barriers
• Restrictive ownership rules
• Close financial markets

These weaknesses create obstacles to free trade among the Arabs.

Opportunities

• Effective use of resources by improving the quality of their human and capital
resources
• Be strong enough to be more global competitive union
• Economic Integration and Arab Common Market
• Creating incentives for Arabs abroad to return to their lands and help their
countries

Threats

• The existing economic and political blocs and globalization

• Lack of vision
• Lack of clear and well-defined banking and monetary systems and procedures
• Foreign economic blocs
• The current tension situation between Arabs and Israel
• Internal competition among Arab countries
• The heavy intervention of foreign sources to evaluate the region's countries
economic significance

Global Consequences of Preferential Trading Arrangements:

Initially it was the first step of the countries towards obtaining a global free trade.
Once countries had adjusted to the new environment and had observed the benefits of
a more liberalised trading relationship, it was thought, and then further steps would

35
follow. Instead, the ability of a region to be self-sufficient and to rely heavily on intra-
regional trade has raised many questions.
By definition, removing barriers within a region while leaving intact the barriers to
countries which are not part of the trading block explicitly discriminates against those
countries. This might leave these left out countries in a very competitive environment
with the newer challenges of a global market.

Interpretation:

It should be noted that these modes of economic cooperation allow countries to

cooperate with each other in order to harness and coordinate the internal and external
resources, skills and power to perform their economic activities more efficiently and
effectively than before (or, to some extent, than others). In short, the collaborators
believe that their success does not require others to fail. They also have a philosophy
that, in the spirit of collaboration, a win-win approach is most effective way to create
a bigger pie and then obtain a bigger share of it.

However, for the Arab world to integrate it’ll first have to meet certain criteria’s like:

The privatization of economy and industry:

The problems of public sector inefficiency in the Arab world call for increase
attention should be a broadly acceptable conclusion. This could reduce the burden off
the government.
However, if the Government intends to do so, it should do it gradually, as the
disadvantages of rapid privatization can outweigh its advantages.

Balancing Physical & Human Capital:

Arab countries like other developed countries should find a closer balance between
the human skills and the technological advancements.

Redesigning Government Controls:

Government intervention in markets has unacceptable political consequences,
particularly the concentration of economic as well as political power in the hands of
politicians and administrators who, being human, will not use it wisely

Political and social willingness, motivation, and strategic fit:

The partners should have a strong motivation for entering the integration relationship.
They should have something of value to contribute to a successful relationship. The
collaborators should have a clearly identifiable source of sustainable competitive
advantage and it should develop an increasing level of interdependence

Interdependence:
The partners should have complementary assets and skills. Neither can accomplish
alone what both can together.

Cultural fit:

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Cultural fit requires that each partner carry out its commitments and shows its trusting
behavior and attitude. They should be able to share the information and knowledge
required to enhance and sustain the relationship.

Institutional arrangements:
The collaborative relationship is given a formal status. So that considering the worse
case scenario the disputes can be resolved.

Integration and integrity:

For best survival opportunities the partners develop linkages and shared ways of
operating so they can work together smoothly. They should build an effective
communication system between many units at many institutional levels.

Conclusion:
Today, the old nature and boundaries of countries and organizations become less and
less useful in organizing economic activities. In effect, an economic alliance or
network based on- cooperation, collaboration, flexibility, adaptation, risk and cost
reduction, shared interest and objectives, and a commitment between different
countries on an integrating ongoing basis-, has been emerged as a more effective
approach to meet the new global environment.
Arab countries, on the other hand, are not being changed quickly enough. They have
not participated fully in the drive to liberalize trade and so have not derived the
benefit they might have by doing so.

References:
http://www.the-saudi.net/business-center/regulation-tax.htm
http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?Symbol=SAR

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http://www.tradingeconomics.com/Economics/Unemployment-rate.aspx?
symbol=SAR
http://www.indexmundi.com/saudi_arabia/unemployment_rate.html
http://www.arabianbusiness.com/581258-saudi-inflation-forecast-to-fall-in-2010
http://www.arabianbusiness.com/582477-saudi-banks-seen-lending-more-in-2010---
ncb
http://www.reuters.com/article/idINL1116639520080211
http://www.tradingeconomics.com/Economics/Balance-Of-Trade.aspx?Symbol=SAR
http://www.indexmundi.com/saudi_arabia/current_account_balance.html
http://www.arabianbusiness.com/582483-oil-exports-to-allow-saudi-economy-35-
rise---ncb
http://www.opec.org/opec_web/en/about_us/169.htm
http://www.indexmundi.com/trade/exports/?country=sa
http://www.opec.org/library/Annual%20Statistical
%20Bulletin/interactive/2008/FileZ/Flowbot.htm
http://www.radford.edu/wkovarik/oil/2worldoil.mideast.html
http://www.arabianbusiness.com/573930-saudi-cenbank-says-usd-peg-beneficial---
paper
http://www.bi-me.com/main.php?c=3&cg=4&id=44740&t=1
http://www.smi.uib.no/pao/zineldin2.html
Textbook: Introduction to Economic 2 ( Heriot Watt University)
Textbook: Economic by McConnell Brue

Prepared By:

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Hijab Amer Pasha 091613372
Muhammad Shakeel 091615413
Muhammad Zawar ul haq 091620152
Hammad Akhtar Mughal 091617026
Muhammad Imran 091615424
Muhammad Imad 091615468
Charanjeet Kaur 091597670

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