May Frances S.

Calsiyao Economics 191- JZ

2003-41755 March 23, 2007

Economic Development in an Oil-Based Economy:

The Case of Saudi Arabia

This paper seeks to analyze the economic development Saudi Arabia. The goal of
this paper is to examine the strategies which brought economic growth to Saudi Arabia.
It also looks at the role that the government played in bringing about economic
development to the country. Finally, it attempts to find out which development model the
country adhered to and what are the consequences of following such a model.
This economy differs from the rest in that it is one of the major exporters of oil,
unlike other economies who serve as oil consumer economies. Oil was discovered in
Saudi Arabia in the 1930s. But large-scale production began only after the Second World
War. This brought economic development into the country. The economy of Saudi
Arabia boomed by the 1970s. Due to the sharp rise of oil revenues in 1974, after the
Arab-Israeli War, Saudi became one of the world’s fastest growing economies. It
enjoyed a substantial surplus in its trade with other countries; imports increased rapidly
and ample government revenues became available for development, defense and aid to
other Arab and Islamic countries. (Travel Document Systems)
Initially, after the 1973/74 sudden increase in oil prices and vastly expanded
revenues, the government pursued what is often referred to in the literature as unbalanced
growth. This strategy entails investment in social overhead (mainly infrastructure)
investments. The projects were attractive to the authorities since they used imported
labor, raw materials and management. Aside from that, they were also highly visible.
The theory underlying this strategy is that it would minimize the amount of decision-
making needed in the private sector. Massive infrastructure investments, by making
profitable investment opportunities readily apparent, would induce the private sector to
greatly step up its investment. In short, the strategy took into account the massive
financial resources of the government as well as the limited entrepreneurial skills of the
private sector. (Looney, 2004)
 As we can see, Saudi was able to achieve economic growth largely though oil
exports. They have adopted an oil-based development model. Saudi’s first two
development plans covering the 1970s centered on infrastructure-building. Then in the
1980s, they shifted their focus to education, health and social services. They also
encouraged the growth of the private sector through investments. The following plans
focused on defense, private sector employment and more efficient provision of social
services. (Travel Document Systems) First, we shall focus on Saudi’s export-oriented
growth strategy.

Export-Oriented Growth in Saudi Arabia

As was said earlier, Saudi Arabia grew economically through export-expansion

strategies. The following graph illustrates Saudi Arabia’s oil production and
consumption. As seen in the graph, oil production highly exceeds that of the domestic
consumption, leading to a high export production. Though exports declined in the 1980s,
it rose up to its previous levels during the 2002 onwards.

Source: EIA
 Although export expansion brought economic growth to Saudi Arabia, it was not
without problems. Because Saudi Arabia is one of the major producers of oil, export
expansion also brought problems to the economy. The figure below shows how Saudi
Arabia incurs trade losses through export expansion. As we can see, because the quantity
of exports increased from the blue horizontal line to the red horizontal line, this will lead
to an increase in the supply of the main export, which is oil. In turn, prices of exports
will go down but prices of imports rise. This will then lead to worsening terms of trade.
Thus the growth that will result will be immiserizing.

Imports
Px

----
Pm

Exports

Another problem encountered by the country is the “Dutch disease.” This refers
to the potentially adverse effects of a booming export sector on the performance of other
exports and of industries competing against imports. In the case of Saudi Arabia the real
exchange rate appreciation resulting from a ramp up of oil exports is likely to reduce the
profitability and competitiveness of traditional agricultural exports. It would also
encourage imports of food and raw materials, which may compete with domestic
production, while discouraging the emergence of new manufacturing exports, essential
for the successful diversification of the economy and the creation of jobs. (Looney,
2004)
The second effect of concern for Saudi development is that, during periods of
modernization and expansion of the oil or gas sectors, the rest of the economy may be
"crowded out" from access to key factor inputs. The hydrocarbon sector with its financial
resources would preempt these resources weakening the ability of the private sector to
invest and diversify. (Looney, 2004)

The Role of the Government in Development

More than 95% of all Saudi oil is produced on behalf of the government by the
parastatal giant Saudi ARAMCO. This means that the government’s role in Saudi’s
development is in fact large. Through 5-year development plans, the government has
sought to allocate its petroleum income to transform its relatively undeveloped, oil-based
economy into that of a modern industrial state while maintaining the kingdom's
traditional Islamic values and customs. Although economic planners have not achieved
all their goals, the economy has progressed rapidly. (Travel Document Systems)
Thus we can say that the development was brought about by the government’s
intervention in the market. This is in contrast to the neoclassical stance which states that
the government should leave the market alone. On the other hand, it seems that Saudi
adhered to a nationalist and Keynesian perspective of development. Lichauco states that
for a country to develop, it must foster industrialization, submit the economy to the
guidance, direction and control of the government and limit the flow of foreign goods
into the domestic market. As we already know, Saudi Arabia underwent industrialization
focusing on its oil industry and submitted its economy to the control of the government.
According to the Chief Economist of the Samba Office, before signing the GATT in
1993, 75 percent of the Kingdom’s tariffs on foreign goods were at 12 percent. Aside
from that, the government itself propelled the development by utilizing its massive
resources for infrastructure investments early in the 1970s. Up to the present, the
government is still playing a primary role in development.
Now we shall discuss the problems that arose from nationalist strategy that the
country has employed in order to achieve development. We shall also look at the
growing problems in Saudi Arabia that the government is currently facing.
Development Issues in Saudi Arabia

Many problems arose from the boom and bust cycle that characterized economic
growth in Saudi Arabia starting from the 1970s. Because economic growth was largely
brought about by the public sector, the ability of the private sector to invest and diversify
was weakened. Currently, small and medium enterprises face these following challenges:
lack of credit, finance and capital, dependence on foreign resources, limited marketing
skills, limited access to technology, bureaucratic hindrances and limited information on
possible markets and clients. (Looney, 2004)
Because the country is heavily dependent on the capital-intensive oil industry and
the private sector is too weak to provide enough jobs for the growing population in the
country, Saudi Arabia now faces a serious unemployment problem. Another factor which
has affected the situation is the dependence of the country on expatriate workforce and
the inability of a youthful Saudi workforce to displace foreign workers. Reflecting this
problem is the high unemployment rate among Saudis which is 8.2% but reaches as high
as 32% among younger workers. (Looney, Feb 2004)
The third challenge is the declining income per capita which stems from the high
population growth. For Saudi Arabia, low economic growth has become a chronic
problem: gross domestic product (GDP) increased by only 1.6 percent between 1990 and
2000 while growth in the country's population grew at an annual rate of 2.7 percent
during that period, thus producing a declining trend in per capita income. (Looney, Feb
2004)
This phenomenon can be described through the Malthusian population trap. The
figure in the next page shows the trap in which Saudi Arabia has entered into. As we can
see, at point A, population growth exceeds rate the income growth rate. This is the
current situation in Saudi Arabia. Malthus suggests that to avoid the trap, technological
innovations has to be made. At the present, Saudi is pushing for economic reforms. Part
of these reforms is the Saudization program. The government is also pushing towards
diversification and strengthening the private sector.
 % Growth

Population growth

Income growth

Y/N
A

Conclusion

In this paper, we have shown how Saudi Arabia was able achieve economic
growth and what are the consequences of the economic development that they had. First
of all, Saudi Arabia used its vast oil resources. The government, which played the
primary role in bringing development to the country, used its massive financial resources
in order to boost the oil industry. It paid off and they achieved high growth rates. But
because Saudi was one of the main producers of oil and can therefore influence the price
of the said commodity, export expansion brought about immiserizing growth. The
development strategies that Saudi Arabia was also identifies as one that followed
Lichauco’s model of development. The country boosted its industrial sector, left the
control of the market to the government and protected its domestic market by imposing
12 percent tariff on imported goods.
But recently, Saudi is moving towards the liberal perspective. In 2005, they had
joined the WTO (EIA, 2007) and prior to had, had prepared their country to open up to
international free trade. This development strategy was conceived due to the problems
that plague their country: high structural unemployment, declining growth rates and a
weak private sector. The effects of this response are not yet known as it is recent.
References:

EIA “Saudi Arabia Country Analysis Brief”

http://www.eia.doe.gov/emeu/cabs/saudi.html accessed March 21, 2007

Looney, Robert “Development Strategies for Saudi Arabia: Escaping the Rentier State
Syndrome” Strategic Insights, Volume III, Issue 3 (March 2004)
http://www.ccc.nps.navy.mil/si/2004/mar/looneyMar04.asp

Looney, Robert “Saudization and Sound Economic Reforms: Are the Two Compatible?”
Strategic Insights, Volume III, Issue 2 (February 2004)
http://www.ccc.nps.navy.mil/si/2004/feb/looneyFeb04.asp

Chief Economist of Samba Office “Saudi Arabia and the WTO” SUSRIS
www.saudi-us-relations.org/articles/2006/ioi/060318-samba-wto.html
accessed March 21, 2007

Travel Document Systems “Saudi Arabia” http://www.traveldocs.com/sa/economy.htm

accessed March 21, 2007