The Role of Structural Transformation and Diversification in Times of Falling Oil Prices
Rowda Al Ali
Diversification encompasses the making of structural changes to a nation’s economy, modifying the employment structure and all the sectors that contribute to aggregate growth. Having a diversified economy requires investing in productive sectors that can sustain real long-term growth. Diversification promotes economic development, creates employment while reducing or spreading the risk of much economic concentration. A successful economic diversification can reduce price volatility and encourage the path to a viable development. Particularly, overall volatility, as well as its subsequent spillover impacts can be circumvented through effective development, increased exports of high-quality products and the diversification of value-added products. Countries, especially, major oil producing nations such as the United Arab Emirates (UAE), have adopted the diversification approach to address the volatility effects of oil prices. Such a move can be viewed as a vital step towards diversifying the country’s growth and economy (Schilir`, 2013). However, several challenges are common. To this point, the UAE has attained variables outcomes in diversifying its economy. This paper will examine the role of structural transformation and diversification in times of falling oil prices.
UAE “Brief” Country Economic Background
UAE became the second largest economy in the Arab world because of its massive oil revenues. Between 2000 and 2012, the growth rate of its gross domestic product (GDP) averaged 4.7% despite the economic hardships and negative international opportunities. Between the 1970s and 1980s, the UAE experienced high growth due to the government’s surplus oil revenue spending on structural growth and infrastructure. However, lower oil prices during the same period presented a major challenge. High inflation and declining economic growth were common during the mid-1980s. Between 1975 and 1999, UAE economy underwent volatile performance because of the increasing population growth. Regardless of its increased concentration on oil revenues, the focus on non-oil sectors led to a decrease in oil revenue from 70% to 40% between 1970 and 1990 (Schilir’, 2013). With more efforts to diversify the economy, 70% of the Emiratis GDP comes from non-oil sectors. However, it is hard to sustain successful growth rates with high volatility oil prices. Meanwhile, the comparative contribution of the other economic sectors have changed remarkably over the years, gas and oil still represent UAE’s largest revenue share. The UAE is vulnerable to fluctuations in oil prices. Besides, its non-oil sectors are not fully matured. They have prevalent structural gaps including inefficiencies in technology, capital, knowledge, and labor.
Economic Indicators Forecast Overview
GDP /GDP per Capita
UAE is not only among the most developed nations in the Arab world, but it also has a high GDP per capita value. Its GDP was $377 billion in 2012. Between 1971 and 2013, UAE economy increased to AED1.45 trillion. Between 1981 and 2012, non-oil sectors grew to AED1.2 trillion. Presently, the GDP is $386.4 billion. Besides its mainly commodity-based economy, its natural gas and oil shipments account for 40% of the overall exports and 38% of its GDP. To diversify its GDP and lower its oil revenues dependence, it has increased investment in financial, construction, tourism, and manufacturing sectors. Manufacturing accounts for 42% of growth output, communication, and transportation for 23%, retail and wholesale for 16% and hotels for 15% (Trading Economies, 2018). Agriculture and hotels are contracted. The UAE’s purchasing power and government spending on infrastructure have increased considerably.
Figure 1. United Arab Emirates GDP per capita 1975-2018 | Data | Chart | Calendar. Source: https://tradingeconomics.com/united-arab-emirates/gdp-per-capita
Labor force / Labor Force by occupation / Labor force participation
The UAE workforce comprises of more than 2.5 million workers of whom 13.5% are women while 86.5 are men. More than 60.2% of expat and 50% of Emirati workers are aged between 25 and 39 years. Gender and age structure reveals that 59.2 % of Emirati workers are concentrated in such category while females account for 63.8%. One-third of Emirati females are employed in specialized jobs that need higher competency, skill, and education. 30% of emirate males are employed as assistant specialists and technicians. The total number of managers, senior staff, and leader legislators among Emirati nationals account for 14.7% of the overall Emirati workforce. Emirati male leaders comprise 15.5% while female leaders comprise 13.3% (Government of Dubai, 2017). The occupations of nationals are concentrated in professionals, businesspeople, managers, legislators, associate professional, and technicians. Non-nationals are mainly employed in elementary occupations such as construction, transportation, retail, manufacturing, restaurants and hotels and private household.Unemployment Rate Forecast 2017-2018
Unemployment in the UAE is the lowest in the globe. Between 2017 and 2018, the rate of unemployment among Emirati female nationals increased while that of the males reduced. That is because many women now have higher and bachelor degrees; thus, they are focused on looking for jobs in specific sectors. Additionally, this had led to a decline in the net rate of economic participation. About 2200 emirates are not employed. The percentage of Emiratis without jobs comprises of 3.4% females and 2.4 % males while the rate of unemployment is 2.8%. The rate of unemployment among non-nationals is 0.3% in which females and males comprise of 0.7% and 0.3% respectively (Government of Dubai, 2017). Since the majority of the workforce is comprised of men, the rate of unemployment will likely continue to decrease due to a declining inflation rate in Jan 2018.
Figure 2. United Arab Emirates Unemployment Rate 1985-2018 | Data | Chart. Source: https://tradingeconomics.com/united-arab-emirates/unemployment-rate
Consumer Price Index Forecast 2017 -2018
By December 2017, the UAE Consumer Price Index (CPI) had increased from 109.36 to 112.29. Between 2008 and 2018, CPI averaged 99.14 points reaching the highest 112.29 in January 2018 (Trading Economies, 2018).
Figure 3. United Arab Emirates Consumer Price Index (CPI) 2008-2018 | Data | Chart. Source: https://tradingeconomics.com/united-arab-emirates/consumer-price-index-cpi?continent=australia
Gross investment /Budget /Public Debt/income distribution
UAE gross investment is about 29% of its GDP. In 2014, the budget was about 5% of the GDP. In 2016, the budget was 46 billion, about 19.1% of its 2016 GDP. UAE public debt is about 41.7% of its GDP. The distribution of income is very high and uneven throughout UAE. Most wealth is concentrated in Dubai and Abu Dhabi. Vast income differences exist among the nationals who comprise 19% of the population. However, they have access to free social services such as social security, healthcare, water and electricity (UAE, 2016). Non-nationals earn inadequate salaries compared to nationals
Industrial production, electricity production /consumption
In 2016, the UAE’s industrial production was 4.4%. Since the discovery of oil, UAE became reliant on it and focused on developing physical infrastructures such as electricity, airports, roads, ports, hospitals, schools and water. Industrial production has focused on boosting infrastructure development and the establishment of other sectors like insurance, banking, trading, building, and construction. Various industries produce domestic and local products such as carbonated drinks, beverages, consumable food, and construction materials. Such industries have increased the demand for electricity. Consequently, this has pushed the energy demand to its limits. Indeed, the UAE is among the highest consumers of electricity per capita globally. From 2014 to 2015, it consumed 114.47 TWH (United Arab Emirates, 2016). Such demand is likely to increase in future. As such, UAE has gradually shifted from the use of gas power plants to generate electricity to the use of renewable energy.
Export /Import volume / Exchange rate
UAE is ranked number 29 as the largest exporting nation globally. UAE is also the 20th biggest importer in the globe. In 2016, it imported goods worth $184 billion and exported $98.8 billion. The primary exports include natural gas, crude oil, dates, fish, gold, diamonds, cars, jewelry, and raw aluminum. The top imports consist of gold, diamonds, cars, broadcasting equipment, planes, spacecraft and helicopters, machinery, transport equipment, foodstuffs and chemical products. UAE’s major destinations include India, Iran, Switzerland, Iraq, and Oman. The main import origins are India, China, Germany, the US and the UK. Over the past seven years, UAE has experienced a decrease in its annual rate of exports. Within the similar period, the annualized rate of imports increased (OEC, 2018). The UAE’s local currency is the UAE Dirham (AED). Its currency has a static parity with the American dollar. However, there lacks exchange control. As of March 26, 2018, 1 USD was equivalent to AED 3.6725.
Major economic challenges facing country
With the volatility of oil prices, UAE has felt its negative influence on economic growth, trading and government spending. Meanwhile, the UAE government has engaged in economic diversification programs and initiatives to neutralize the influence of the declining oil prices, several challenges are evident. Particularly, diversification policies and reforms have proved demanding to implement since decision-makers fail to determine the future economic vulnerabilities. Besides, the continuing dependence on oil is contributing to the implementation challenges. Diversifying the economy offers the country a better approach to overcoming the financial crisis and the effects of declining oil prices. Besides, when the global financial crises affect every sector of the economy, it is hard to determine how the non-hydrocarbon sectors can recover from the shocks. As such, some of the UAE diversification strategies have proved unsuccessful since its oil production prospect is still too long (Said, 2016). The failure and success seem to rely on the implementation of the suitable policies ahead of the declining oil revenues. Diversification also needs time to implement.
Falling Oil prices ; effect on Government budget and Sovereign Fund
The declining oil prices have a significant influence on government budget and spending. The government is forced to cut on energy subsidies and halt non-critical projects vital to economic diversification. The government considers the other sectors to fund its budget besides increasing taxes. It also uses its financial reserves. Therefore, the amount proposed for the annual budget is likely to be limited due to reduced oil revenues (Consultancy.uk, 2016). Low GDP growth results in slow economic growth. Often, surplus funds from oil revenue enable the UAE government to deploy its wealth and pursue strategic objectives successfully. The Sovereign Fund allows the government to create long-term value. It pursues medium and long-term tactical prospects that generate returns from long-range investments. However, with the volatility of oil prices, it has become hard for the Fund to diversify its portfolio (Oxford Business Group, 2015). Therefore, sovereign funds not only become strained but the government also uses them to control economic growth.
Financing Budget Deficit in Times of Falling Oil Prices
The decline in oil prices leads to reduced government spending and budget revenues. Accordingly, this impedes the government’s funding of sustainable economic development programs. Reduced fiscal balances cause a rise in the debt burden, as well as threatens the long-term financial sustainability. Undoubtedly, reduced oil prices have a significant influence on the country’s fiscal balance and economy. Diminishing inflows to the financial system cause a decline of the government budget income. Since hydrocarbon products account for a significant percentage of the government budget revenue, low oil prices influence almost all the aspects of the UAE’s fiscal policy. In effect, the financial policy alterations made in reaction to the new situation includes shifts in budget revenues. It also leads to changes in the budget spending structure such as recurrent and capital expenditures and new financing sources to control the budget deficit (IMF, 2012). Both the spending and revenue aspects of the financial policy encounter strict limitations.
Population, Local skilled labor, Emiratization
Population imbalance in the UAE is a significant challenge to policymakers. Non-national residents comprise of the majority than the nationals. The non-national’s dominant presence presents social, political, economic and security challenges. Additionally, the Emirati population’s small size and their lack of a necessary skilled workforce after independence compelled leaders to invite expats to support the building of the nation, as well as the development of economic projects. Since then, the reliance on expat workforce has remained inevitable. The UAE has experienced unprecedented growth rates, which has changed it from a modest Bedouin civilization to a very intricate multicultural and multinational nation. Accordingly, there are deep security, stability, and internal order anxieties among nationals. Besides, foreign workers bring with them diverse traditions, religions, languages, and lifestyles, which are a threat to the locals’ cultural identity; thus, they view them as a security threat (Fanack, 2018). Additionally, such a circumstance is made increasingly intricate by the increasing unemployment among the local youths, the need for diversification and the knowledge economy.
Slow job growth and unemployment are major issues in the UAE. Debatably, unemployment is challenging UAE’s political and economic stability. Currently, the overall UAE population is about 8 million and continues to grow at a rapid pace. However, about 20% of the population comprises of Emirati nationals. From this population, male and female consists of 70% and 30% respectively. UAE labor market has unevenly distributed employment and serious structural imbalances. Such a trend can be attributed to the declining and minor share of Emirati workers in the overall workforce. The dominance of foreign workers increases competition for job opportunities available for Emirati nationals (Nour, 2016). Since foreign workers are considered more productive, flexible and cheap, private companies prefer them; thus leaving the nationals unemployed.
Slow Economic Growth
Weakening oil prices lead to slow economic growth. Low oil prices also result in a slow increase in budget deficits, erosion of financial reserves and increasing debt. With a dramatic decline in oil prices, it is hard for the UAE government to implement its diversification plans. Slow growth also means every sector of the economy is constrained because of limited expenditure. As a result, it limits the UAE’s capacity to attract outside funding, sustain investor confidence, as well as reduce the influence of modification measures on domestic liquidity and growth (Trade Arabia, 2016). The slow growth of the economy also presents a major challenge for public finances and exports
Education is a necessary and vital prerequisite to facilitate human capital. It is also the primary determinant of economic growth in the Emirates. The UAE’s education system is essential in its knowledge economy because it teaches attitudes and skills. Since education is connected to the workforce’ skills, it is pivotal for employment. However, the primary challenge lies in overcoming the wage gap between the private and public sector. On the other hand, there is a perceived inflexibility in the labor market (Fanack, 2018). The labor market is ineffective since the education system is not linked to the market needs of the high-value industries.
The UAE continues to experience soaring domestic inflation, which is often linked to the relaxed allowance of the money supply. Accordingly, this has had a considerable influence on the stability of the actual exchange rate’s constructive reception among several nations. Through pegging its currency to a relatively low-inflation currency, the UAE tries to integrate and control inflationary pressures. Although such a policy has enabled to lower inflation considerably, at the same time, it has created constant exchange rate increases, loss of global competitiveness, strong budget and trade deficits and fluctuations in GDP growth rates. Conversely, the UAE’s fixed nominal rate of exchange policy and the cautious anti-inflation policies have resulted in the overvaluation of the aggregate real exchange rate (UAE, 2016). Indeed, high inflation is a major challenge the country faces.
Foreign Direct Investment
For UAE, the most considerable challenge it faces is shifting from the conventional approach of luring foreign direct investment (FDI) to a contemporary dynamic FDI approach. The UAE’s former FDI strategy tends to rely significantly on free zones. As such, it has failed to offer its foreign financiers with a generic setting that attract high-quality FDI. Additionally, the current legislation concerning UAE investment, as well as FDI is lacking. As such, foreign investors have no access to a more certain and stable investment climate (Al-Jaber, 2008). Without clear guidelines and regulations, FDI faces overarching risks. Such a situation is made worse with the volatility of oil prices, slow GDP growth, government spending, and fiscal deficit.
The UAE has created the most developed and advanced infrastructure within the Arab world. From airports to roads to rails, it offers a hub of world-class facilities, which drive its economic growth, as well as facilitate business development. With such connected systems and networks, the UAE links its main population centers and transportation hubs. These systems also connect UAE with the rest of the Arab world; thus, facilitating trade. However, several challenges emerge with the development of these infrastructures such as congestions, traffic, pollution and security risks. Another challenge is attaining a green and sustainable economy by reducing the carbon footprint. Therefore, the UAE is still facing the problem of shifting from the use of oil to using renewable sources of energy (UAE, 2018). With the continued use of hydrocarbon products in these infrastructures, UAE has failed to attain its sustainability and competitiveness through environmental preservation.
IV. Volume of trade with China, India South East Asia, Japan and other Arab countries compared to the rest of the world
The UAE’s volume of trade with other nations continues to increase. Given the UAE’s economic growth and major trading partners, its annual exports and imports will grow. UAE’s exports comprise of manufactured goods, fuels, metals and ores, which represent 79% of the overall exports. UAE mainly imports from the US, India, and China. These three countries account for half of the UAE imports. The major export markets include India, Japan, and Iran comprising of 49% of the total exports. Regarding trade volume, the important trade flow currently involves products, fuels and manufactures from India (UAE, 2016). The most vital export flows are fuels to Japan, Taiwan, and South Korea.
V. Recommendations for Macroeconomic Policies in times of falling oil prices
Considering the discussion above, the government should implement a new framework for developing the entire UAE. Such a framework must envisage more on a diversified knowledge-based economy (IMF, 2017). Creating a diversified economy must be founded on knowledge, which is critical to strengthening the connection between human capital, learning, education, and innovation
The government must create reforms, which encourage job creation and diversification. It can be done by constant investment in infrastructure, more advancement in the business environment, enhancing training and education, advancing job placement services and modifying the incentives of private and public jobs. The government must distribute labor among various economic sectors through nurturing a skilled workforce generated by increased productive investment in human capital.
Instead of focusing on oil revenues, the UAE must concentrate more on promoting the structural growth of non-oil sectors. The government must also create effective exchange rate and monetary control policies (IMF, 2017). Such monetary and fiscal policies must focus on controlling government spending, taxes, deficits, debt, and budget
The discussion above has reviewed the role of structural transformation and diversification volatile oil prices. The review has investigated the vital factors, which characterize a diversified economy, as well as the policies that the UAE must implement to develop and diversify its global level performance. The ineffective oil wealth allocation, misguided investments, unskilled workforce, and weak fiscal policy present several challenges. Therefore, the government must offer programs and incentives that increase financing and training of the workforce to join and grow the non-oil sectors. The UAE must diversify its economy by investing in non-oil sectors. It must also extend its exports and imports to strategic partners. Besides, to attain sustainable growth and economic diversification, the government must examine its domestic fiscal system to finance more real domestic investment.
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