Foreign Policy Blogs

Saudi Arabia and the End of the Rentier State

A view of the Royal Tower overlooking the town of Riyadh, the capital of Saudi Arabia. (Reuters)

A view of the Royal Tower overlooking the town of Riyadh, the capital of Saudi Arabia. (Reuters)

Saudi Arabia got a headline-making endorsement of an ambitious economic diversification plan last week, when General Electric (GE) announced it would invest at least $1.4 billion in the country. GE will partner with Saudi firms in the creation of a new $400 million manufacturing facility, creating 2,000 new jobs specifically geared toward Saudi nationals.

The news was primarily featured in the business pages, but the move comes at a critical time for Saudi Arabia. With a young, restless population and crumbling oil revenues, the largest of the Gulf monarchies needs investment inflows like this one to shake off its rentier economic system and build a more sustainable model. While relations between Riyadh and Washington might be chilly at present, both the U.S. and Europe have a strong interest in helping the Saudis achieve their goals.

Saudi Arabia has always been a notoriously inward-looking nation, but it is now waking up to the realization that its 20th century model of oil revenues and authoritarianism will not be able to sustain it in the 21st century. While lavish public spending helped contain the frustrations that fueled the Arab Spring elsewhere, the oil price crash has forced the Saudis to embark on painful (but necessary) economic reforms.

Since King Salman took over the reins of power last year, his son and economic chief Prince Muhammed bin Salman has made it easier for outsiders to put their money in the Saudi stock market and even offered to sell a (small) piece of Saudi Arabia’s national oil company, Saudi Aramco—whose books have practically been state secrets up until now. The Kingdom, it seems, is suddenly open for business.

These changes have collectively been grouped within an economic reform drive dubbed Saudi Vision 2030. The ultimate goal, as the Saudis put it, is to build a “prosperous and sustainable economic future” for the kingdom. The crux of the challenge is to wean the nation off its dependency on oil, which would be no small feat: in 2014, energy exports provided 85% of Saudi’s export revenues and 90% of government revenues.

Saudi Arabia is hardly the first country in the region to embark on this process of “de-oilification.” Last year, the United Arab Emirates began dismantling their energy subsidies program, taking advantage of the oil price slump to cut benefits at a time when their impact would be felt the least. Elsewhere, Iran’s subsidy reforms saw President Hassan Rohani raise petrol prices by 75% in 2014, from 4,000 to 7,000 rials (16 cents to 28 cents) per liter.

On both sides of the Persian Gulf, policymakers are well aware that the last decade of skyrocketing oil revenues is squarely in the past. Without them, the largesse that has traditionally formed an essential part of the region’s social contract—social services in exchange for political compliance—has to be cut accordingly.

To the Saudis and the other rentier states of the Middle East, Dubai’s success in particular has shown its neighbors a life beyond oil is possible, provided they can attract the right types of outside investment. The Financial Times’ global FDI report ranks Dubai 4th in terms of greenfield projects and 6th with regard to attracting foreign capital. Oil revenue made up around 25% of the tiny emirate’s real GDP in the early 1990s, but that ratio has dropped to just around 1.5% today.

Looking more broadly, there are geopolitical ramifications to ending the reign of rentier economics in the Gulf. The reliance on oil revenues as opposed to tax receipts has long been blamed for the region’s governance issues. The move away from oil offers a chance to reshape how governments fund themselves and rewrite Arab social contracts. Instead of a paternalistic relationship where government pays for the public’s needs and expects obedience in return, more vibrant market dynamics would make governments more accountable.

In the short term, however, drastic changes will leave these Arab countries in a state of flux. With the collapse of state institutions already ravaging the region, giving rise to jihadist groups like ISIS, and pushing refugees into Europe by the thousands, both the United States and Europe have considerable incentives to make sure these economic transitions go as smoothly as possible.

While most of the states in the region look to the United States first and foremost as their outside partner of choice, European states have just as many tools at their disposal in moving Middle Eastern governments away from unsustainable rentier economics. Some of them already have substantial business ties to the area: the UK, for one, has had an active role in the Persian Gulf going back to the 19th century. British businesses and expats are a major presence in Saudi Arabia, Dubai, and the other Gulf emirates.

The defense industry ties linking London and Riyadh (worth $4.4 billion in 2015) have been a point of contention in Brussels, but the relationship between the two countries goes well beyond that. By using private investment as a tool to encourage better economic governance Britain, Europe, and the US could make Riyadh’s recent change of pace into a beneficial regional trend and offer both moral and concrete support to a successful (read: calm) transition.

From the Saudi’s perspective, outside funding is essential if their grand plans are to come to fruition. High-profile outreach visits, like last year’s visit to Washington, shows just how seriously Riyadh takes the task ahead. Just as he should.

Against the backdrop of waning oil prices, an estimated 37% of Saudis are younger than 14 and two-thirds of the nation’s 29 million people are under 30. This means huge swathes of young Saudis are either in the labor market or about to join it, and the Saudi economy as currently structured has neither the jobs nor the capacity to incorporate them.

Riyadh needs many more announcements like GE’s to make sure young citizens can go without the subsidies it must now do away with.