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For GCC states, liberalizing the labor market and developing the local workforce are the keys to moving beyond a reliance on foreign workers.
Gassan Al-Kibsi, Claus Benkert, and Jörg Schubert Web exclusive, February 2007 Bahrain’s economy is growing at more than 5 percent a year, and per capita income averages about $15,000. However, such statistics make little difference to Jafar Ahmed Ali, a 30-year-old Bahraini citizen who works more than 12 hours a day, seven days a week, for a construction company. Like many Bahraini nationals, Jafar faces stiff competition from foreigners willing to work for less than half the minimum—$500 a month—that he needs to support his family. Even after four years with the same employer, Jafar can’t beat the system. In Bahrain and the five other states that make up the Gulf Cooperation Council (GCC)— Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE)—foreign workers hold the majority of private-sector jobs. At the extreme, in the UAE, foreigners account for 99 percent of the private-sector workforce (Exhibit 1). This situation has led to high unemployment among GCC nationals, declining productivity, and a growing social malaise (caused in part by weak job prospects and poor working conditions) that could threaten the region’s economic prospects.
About the artwork: Paul Guiragossian 1987
An estimated 42 percent of the GCC’s local population is currently under the age of 15 and will soon be in search of work. Yet the public sector—where GCC governments have traditionally employed up to 90 percent of the national workforce—is now too bloated to accommodate large numbers of new entrants. Meanwhile, the private sector, which would need to double both the number of jobs and the salaries of individual jobs by 2015 to meet this increase, does not currently offer the sort of high-salary employment that would attract nationals. Clearly, the policies that served a purpose 30 years ago have reached the end of their usefulness. The preponderance of foreign workers dates back to the oil boom of the 1970s, which helped finance the establishment of the GCC’s modern industrial infrastructure. This massive undertaking required a larger labor force than was available locally, not only because nationals were few in number and short of skills, but also because they shunned the kind of physical labor associated with building infrastructure. To solve the problem, GCC governments introduced immigration policies designed to attract foreign workers.
This dependence on cheap foreign labor has delayed the formation of a skilled national workforce and prevented the development of a diversified and productive private sector that could help absorb new entrants into the workforce. Addressing these challenges is vital to the further expansion and diversification of the GCC economies in order to shield them from the effects of volatile oil prices. A workable solution will require comprehensive—and painful—reversals of the GCC’s immigration and national labor market policies. Instead of promoting loose immigration and rigid labor markets, GCC governments should tighten immigration controls to raise the cost of employing foreign workers while also liberalizing national labor markets to promote competition among nationals and expatriates for jobs. At the same time, GCC governments must take measures to promote vocational-skills training for nationals to help them compete more effectively for those jobs.
The high cost of cheap labor
The labor problem persists in part because the GCC states’ policies allow foreign workers from countries such as Egypt, India, and the Philippines to fill private-sector jobs at wage levels much lower than GCC nationals would accept and in sectors they traditionally have shunned, such as construction and manufacturing. But as increasing numbers of women and new graduates have entered the national workforces, public-sector employment costs have ballooned. For the GCC as a whole, the central governments’ bill for wages exceeds 11 percent of GDP, on average— and 17 percent in Saudi Arabia.1 By comparison, among the G8 nations2 the wages of central-government employees account for 4 percent of GDP, on average, while total wages for the public sector (including regional governments and municipalities) average approximately 9.5 percent of GDP. GCC governments pay additional costs for foreign workers in the form of subsidized health care, infrastructure, electricity, gas, and water. Neither employers nor expatriates pay taxes that would allow governments to recover these costs, and current immigration and health fees are insignificant. Our analysis shows that every expatriate in the GCC generates social costs of approximately $1,300 a year. Meanwhile, foreign workers in the GCC remit about $35 billion a year to their home countries—approximately 10 percent of each host state’s GDP. Even if current oil revenues could sustain the existing labor system, they are no match for demographic trends in the GCC. Expanding populations, along with increasing numbers of women entering the job market, have already pushed up unemployment rates among the national populations of Bahrain, Oman, and Saudi Arabia to 10 or even 15 percent; unofficial sources report unemployment among 16- to 24-year-olds of more than 35 percent in these states. As a result, nationals seeking work in the private sector have had to lower their wage and status expectations. Over the past decade the abundance of cheap foreign labor has contributed to a decline in the private sector’s average real wages of 16 percent in Bahrain to 24 percent in Saudi Arabia (Exhibit 2). The low-skill segment of the labor market has taken the brunt of the fall. Today private companies in Bahrain, Oman, and Saudi Arabia pay nationals an average monthly wage of $460 for manual labor. But most GCC households require at least $900 a month to meet their current living standards.
Meanwhile, with private companies finding it cheaper to employ expatriates than to invest in more capital-intensive production methods, productivity rates throughout the GCC are also on a downward spiral, dropping by as much as 20 to 35 percent over the past decade. In the construction sector, the GCC states’ 2005 productivity figures were only a quarter of the US ones. Consequently, private companies offer few jobs that appeal to well-educated nationals. In Bahrain during the past decade, for example, for every ten college graduates, the private sector created only one job that paid more than $500 a month. We estimate that over the next decade, the private sector in the GCC states will need to increase the number of medium- to high-wage jobs fivefold to soak up the 280,000 new national workers expected to graduate each year with at least a secondary-school education. By 2015, to achieve full employment across the GCC, the private sector will need to create 4.2 million new jobs for nationals—almost double the number of jobs that exist today (Exhibit 3). While all GCC states face the same structural challenges, the incentives and internal pressures to reform differ from state to state. The situation is especially acute in Bahrain and Oman, since their oil reserves are nearing depletion and government revenues will be unable to prop up public employment. Saudi Arabia also faces a demographic challenge, as its national workforce is outgrowing oil revenues. In the wealthier states of Kuwait, Qatar, and the UAE, the crowding out of national job seekers by foreign workers is less acute. In all GCC states, labor market reforms will be politically painful but ultimately inescapable. Young citizens are likely to press for change, and the GCC states will need to take action to build sustainable economies.
To date, GCC governments have addressed labor market imbalances by trying to minimize immigration through strict sponsorship rules for foreign workers and limiting contracts for such workers to two years. Governments have also set quotas to increase the number of nationals in private companies and have limited the circumstances in which they can fire national workers (a policy that, in effect, makes expatriate labor even more attractive). Initially, private companies complied with these measures, treating the quotas for nationals as a kind of tax. But GCC governments have gone on raising the quotas, to increase the number of nationals employed in the private sector. Since 2000 Oman’s government, for example, has allowed only nationals to fill low-skilled jobs in categories such as driving taxis and trucks and operating grocery shops. Recently, Oman added 24 categories to the nationals-only jobs list. In 2005 Saudi Arabia passed a labor law requiring that nationals make up 75 percent of a company’s workforce. The GCC’s education system fails to prepare students for work: basic training is inadequate, and the region lacks systematic vocational training
Companies routinely resist these measures, complaining that they cannot find sufficiently qualified nationals to fill open positions. A key problem is that the GCC’s education system fails to prepare students for work: the basic education is inadequate, and the region lacks any kind of systematic vocational training. Few nationals achieve the level of skill that would allow them to land jobs in the higher-paying segments of the workforce. In a ranking that measures achievement in math among eighth-grade students, Saudi Arabia, for example, is near the bottom, between Botswana and Ghana. About 90 percent of first-year students at UAE University require one year or more of courses in basic math and literacy. Furthermore, by mandating the employment of nationals, the quota system gives them less incentive to compete effectively for jobs. According to interviews conducted with private-sector employers in Bahrain, Saudi Arabia, and the UAE, a quarter of national employees fail to show up for work regularly, while many leave jobs just six or nine months after taking them, citing boredom or a lack of interest. Some companies even choose to pay low-performing employees simply to meet the quota but ask them to stay home. Companies have developed a variety of schemes to avoid quotas. The most straightforward is to negotiate with government authorities, on a case-by-case basis, for additional expatriate labor. As a result of this approach, companies within a given sector are treated unequally, which opens the door to corruption and favoritism. It also encourages civil servants to micromanage private businesses. Some businesses bypass the bureaucracy altogether and list “ghost workers” on their payrolls. Ghost workers are nationals whom companies employ only on paper to meet their quota requirements; once they fulfill the quotas, they can obtain more expatriate work permits. Other businesses get foreign workers through a system of “ghost companies”—shells registered in sectors (especially construction) with low quotas for national employees. The only business these companies do is importing foreign workers and releasing them illegally into sectors with more restrictive quotas, often by selling sponsorship rights to other employers. Our analysis suggests that 25 to 30 percent of the GCC’s expat workforce falls into this category. Since most private companies view the circumvention of quotas as a necessary part of doing business, such practices have become so widespread that governments accept them tacitly.
Narrowing the local-expatriate cost gap
The GCC could eliminate this brew of corrupt practices by reversing current labor policies. All developed economies, for example, manage their labor markets through a system of controlled immigration, achieved by placing quotas on immigrants, establishing a system of fees, or both. Once foreign workers enter a developed country, however, they typically enjoy the same rights—such as job mobility, transparent termination rules, and limits to the number of hours they can be required to work—as their national coworkers. These policies serve both to equalize the cost of employing foreign workers and nationals and to make the labor market more flexible. Research shows that flexible labor markets help raise employment levels.3 GCC states need to clamp down on immigration by adopting the comprehensive approach found in developed economies. Doing so will raise the cost of foreign workers compared with the cost of nationals and forestall further increases in expatriate populations. Taxes on immigrant labor should be particularly effective in the GCC, since they enable governments to recover some of the costs associated with foreign workers. Quotas, on the other hand, drain money out of the economy, since most foreign workers repatriate their earnings. Critics argue that fees on foreign labor could increase inflation and drive private companies to other low-cost destinations. But while an increase in labor costs of $250 per month per worker (which would raise the cost of employing expatriates to about $570 and close the cost gap between expatriate and local workers) would boost consumer prices 4 to 8 percent over five years in Bahrain, for example, that additional cost would be unlikely to drive away private companies. Surveys show that investors place a higher value on other factors, such as access to markets, incentive systems, and the availability of skilled labor. Since most private companies view the circumvention of quotas as a necessary part of doing business, such practices have become so widespread that governments accept them tacitly Our analysis suggests that gains in productivity could exceed the additional costs associated with fees on expatriate labor. Moreover, these gains will end the cycle of decreasing wages. The fees would give businesses incentives to increase their productivity, since more capital-intensive production methods reduce overall labor costs. At the same time, such methods create higher-paying jobs that appeal to national workers. Our analysis suggests, for example, that if the GCC’s construction companies
raised their labor productivity by 60 percent, to match that of Turkey, they would more than offset the cost of labor fees or expatriates. GCC governments must take additional measures to let all participants in the labor market, regardless of national origin, compete for opportunities on their own merits, under the same termination rules and with equal job mobility. As the cost of importing workers rises, the governments should boost the appeal of employing nationals by gradually eliminating quota laws and onerous termination processes. Similarly, the governments should eliminate current sponsorship requirements that tie foreign workers to a single employer for two years. Instead, these workers should be able to transfer their work permits to other employers if and when they choose to find new jobs. This policy change will enable expatriates to compete freely for jobs and release them from what now resembles a system of indentured employment. Moreover, foreign workers will be likely to flock to the best-paying, most desired jobs, thereby pushing up overall wage rates and helping to level the playing field for nationals and expatriates. Other GCC governments should consider some combination of the reforms that Bahrain recently pioneered, notably the introduction of a tax on foreign workers and the use of the resulting revenue to improve the quality of the domestic workforce. The current tax level is about $690 per worker per twoyear employment contract, and the government plans to increase the tax annually for the next few years, until the cost gap between expatriates and locals closes. As labor fees increase Bahrain will gradually relax quota regulations. The government will discontinue quotas altogether once the fees reach a level that eliminates the cost gap between expats and nationals. Emerging markets can win in the global war for talent by leveraging the skills of their expats. See “Brains abroad.”
Improving the national workforce
The success of immigration reform hinges on concomitant employment and education programs to assist the region’s national workers. Instead of trying to protect them from low-cost foreign competitors, governments should invest in building their skills so that they can become the employees of choice. To do so, governments should establish multitiered employment programs that include training in skills for nationals, financial incentives for companies to employ them, and job-matching services for employers and job seekers. Bahrain’s recently established Labor Fund invests the taxes on foreign workers—which will eventually generate about $500 million a year—both in skill-building programs for the national workforce and in measures to increase privatesector productivity (such as subsidies for upgrading accounting and IT systems and for consulting support to identify opportunities to improve productivity). The fund has also increased the level of loan financing for small private companies by guaranteeing access to loans from commercial banks. GCC governments should also consider establishing private-sector apprenticeships that enable their nationals to acquire on-the-job training while earning a wage. Since companies are reluctant to employ nationals, governments may need to entice them with subsidies to cover the cost of the apprenticeships. To be manageable and effective, these subsidies should taper off gradually over the course of, say, two years, as a worker becomes more productive. So that employees have an incentive to stay in their jobs, governments could work with the private sector to offer bonus payments when they achieve milestones (for example, the successful completion of a probationary period or of the full apprenticeship program). Governments can further improve the employment prospects of nationals by offering job-matching services, such as job databases and career counseling. Matchmaking programs work best when they segment job seekers along the dimensions of skills and motivation. A successful matching effort would place low-skilled but motivated candidates in training programs. Less-motivated candidates would be required to attend basic job-readiness programs focused on work ethics before receiving specific technical training. Such employment initiatives don’t come cheaply. Our initial estimate for matchmaking support and job training for the entire GCC over the next decade ranges from $4 billion to $5 billion. Wage subsidies for noncompetitive nationals will add a further $10 billion to $15 billion over the next ten years, depending on the duration of the subsidy and the employee eligibility criteria. The total for the next decade represents approximately the entire annual spending on education by GCC governments. Address-ing these structural issues now will be less of a burden for the wealthier, smaller states of Kuwait and Qatar, since their national workforces are still small. In the case of Bahrain, however, a more painful approach that relies on taxing employers of foreign workers is the only feasible solution to help finance these costs.
In all GCC states, financing labor market reforms is likely to be easier than overcoming private-sector resistance. Ultimately, however, labor market reform is inescapable. As GCC job seekers grow in numbers, they will find it increasingly hard to accept the idea that their fast-moving economies do not offer well-paying jobs. Companies also will find it necessary to move toward higher-paying, more-value-added jobs if they want to compete in the global economy. On top of these internal drivers, Western countries will continue to use bilateral and multilateral trade negotiations and other forums to pressure GCC governments into setting minimum standards for the work conditions of expatriates. The GCC’s growing economic power, after all, will be considerably less welcome if accompanied by excessive “social dumping.” By addressing the demographic pressures now, GCC governments can stave off potential social unrest, avert international criticism, and propel the economies of their countries toward a sustainable future.
About the Authors
Gassan Al-Kibsi is a principal and Jörg Schubert is an associate principal in McKinsey’s Dubai office; Claus Benkert is a director in the Munich office.
Ugo Fasano and Rishi Goyal, “Emerging strains in GCC labor markets,” International Monetary Fund working paper, number WP/04/71, April 2004; and Kingdom of Saudi Arabia, Public Administration Country Profile, Division for Public Administration and Development Management (DPADM), Department of Economic and Social Affairs (DESA), United Nations, September 2004, p. 4.
Canada, France, Germany, Italy, Japan, Russia, the United Kingdom, and the United States.
“Recent labour market developments and prospects,” OECD Employment Outlook 2004 Edition, pp. 23–72; and David Kucera, “Unemployment and external and internal labor market flexibility: A comparative view of Europe, Japan, and the United States,” Schwartz Center for Economic Policy Analysis working paper, number 1998–21, October 1998.
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