Between 2014 and 2016, Middle Eastern oil-exporting countries’ revenues fell by an average of more than one-third – or 15 percent of GDP – and their current-account surpluses have swung violently to double-digit deficits.
Notwithstanding a small recent uptick, most forecasts predict that oil prices will remain at current levels for the long term.
If so, this will deliver a macroeconomic shock of historic proportions and profoundly change the Middle East.
Most oil-producing countries have already started to cut expenditures, borrow, and draw down their reserves. But countries with large external imbalances, low reserves, or high debts will increasingly feel financially constrained, if they don’t already.
Low oil prices will hit Algeria, Bahrain, Iraq, Iran, Oman, and war-torn Libya and Yemen before the richer countries of the Gulf Cooperation Council. But, ultimately, each country’s economic fate will depend on the choices that it makes today.
Oil-producing countries can either cut consumption, or maintain it by improving productivity. Naturally, any country would prefer the latter, so the region’s governments are now trying to grow out of their problems by diversifying their economies.
Fortunately, the region is better positioned for a growth takeoff than it was in the 1990s, owing to major education and infrastructure investments that were made during the last decade of high oil prices.
But to avoid deep cuts to current consumption, any credible growth strategy will have to put structural reforms before even macroeconomic stabilization, lest failure to deliver growth leads to a financial crisis and even deeper consumption cuts in the future.
Whether the region’s governments are finally serious about implementing real change remains to be seen.
The lessons of the last oil shock, which came on the heels of a collapse in state-led industrialization in the mid-1980s, were hard to absorb.
Because governments had borrowed to avoid making necessary adjustments during the 1973-1985 oil boom, the eventual bust precipitated a debt crisis.
Most countries had no choice but to cut expenditures and accept a lost decade of anemic growth.
Since then, governments across the region have resorted to crude repression to keep public discontent and political opponents at bay.
By the end of the 1990s, they had restored macroeconomic balance, but implemented merely superficial structural reforms.
And when growth did return, in the 2000s, it was driven almost entirely by another oil boom.
As in the 1980s, the region’s governments today have tied oil revenues to consumption subsidies, public-sector employment, and public investment.
When adjustments are needed, they generally take the form of fiscal cuts, rather than structural reforms. And these cuts have mostly hit public investment, thus undermining future growth prospects.
Now that oil prices have plateaued, private investment is falling, domestic firms are idling, and unemployment is rising.
More fundamentally, governments in oil-producing countries are confronting a political dilemma: Stronger economic growth, though desirable, requires regimes to take risks that could endanger their very survival.
Decoupling oil revenues from public subsidies will require a new social contract that is based less on guaranteed consumption and more on personal autonomy.
But, while a diversified economy presupposes more space for private enterprise, governments in the region, especially during boom times, have tended to favor politically connected firms, and blocked those they view as a threat.
This practice has always impeded competition, distorted bank lending, and reduced economic dynamism; but it has helped autocrats preserve their power.
Unfortunately, this system of patronage and clientelism has become only more entrenched since the Arab Spring, as governments have increasingly had to buy political consent.
Oil exporters, with the exception of Libya and Yemen, may have avoided major political changes, but the autocratic bargain – and any attempt to unravel it – has become more expensive.
Some regimes will be tempted to stick with the status quo, hope for a recovery in oil prices, and crack down harder on civil society in the meantime.
If that happens, the situation could turn out even worse than in the 1990s. The region’s people have grown even more accustomed to high levels of state spending, and the public discontent revealed by the Arab Spring has not disappeared.
Those countries that opt for reform will require not only political courage, but also well-crafted policies.
In most Middle Eastern countries, labor-market participation is now among the lowest in the world, and energy-to-output ratios are among the highest.
To increase productivity while preserving social stability, subsidies should be removed with the goal of improving efficiency, not simply to make fiscal cuts. And a new fiscal-transfer system should be established to support investment rather than consumption.
However, governments cannot simply liberalize markets and hope for the best. The region’s private sector will need active, sustained support to grow and mature.
Managing mixed economies that include state-owned enterprises and an inchoate private sector will require discipline, so that productive assets are not squandered, or privatized at fire-sale prices.
External imbalances will pose the largest challenge for the region. Exchange-rate flexibility is not particularly useful when a country has no export capacity, and establishing import or foreign-exchange controls would only generate corruption and rent-seeking.
Still, some countries may have room to raise tariffs on certain consumer goods. And if they develop renewable-energy sources and step up their conservation efforts, they can increase their energy exports.
It is hard to predict what a future of low oil revenues will mean for the Middle East. The region’s elites can either embrace change, or do nothing and risk a precipitous decline.
The time to choose is running out.
Copyright: Project Syndicate
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