A Talk on Diversification Reda Cherif and Fuad Hasanov - PDF document

A Talk on Diversification Reda Cherif and Fuad Hasanov International Monetary Fund Central Bank of the UAE May 23, 2016 D ISCLAIMER : T HE VIEWS EXPRESSED HEREIN ARE THOSE OF THE AUTHORS AND SHOULD NOT BE ATTRIBUTED TO THE IMF, ITS E XECUTIVE B OARD , OR ITS MANAGEMENT .

Avoiding Another Large and Lasting Decline in Welfare… Real Consumption per capita and Real Oil Price, 1980 – 2010 115 50 45 110 40 105 Average NFA/GDP: 3 percent in 1980 vs. 54 percent in 2006 35 Constant (1982-84) $/barrel 100 30 Index (1980=100) 95 25 20 90 15 85 10 Real Consumption Per Capita (PPP) Real Oil Price (RHS) 80 5 75 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

…and Reversing Relative Income Decline GDP Per Worker (PPP $), 1970 – 2010 400,000 400,000 350,000 350,000 Bahrain Kuwait 300,000 Oman Qatar 300,000 Saudi Arabia United Arab Emirates 250,000 250,000 200,000 200,000 150,000 150,000 100,000 100,000 50,000 50,000 0 0 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

The Current Model Relies Heavily on Oil Average Oil Exports (% Exports) 100 100 1980s 1990s 2000s 90 90 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 1/ U.A.E. Goods and Services exports excludes re-exports.

The GCC Achieved Large Improvements in HDI and Living Standards GCC Life Expectancy, 1980 – 2012 (Years) 80 80 75 75 70 70 GCC Bahrain Kuwait 65 65 Oman Qatar Saudi Arabia 60 60 United Arab Emirates 55 55 1980 1990 2000 2012

Yet Export Sophistication Has Not Improved Goods Export Sophistication: 1976 – 2006 14000 14000 Kuwait Oman 13000 13000 Saudi Arabia U.A.E. Indonesia Malaysia 12000 12000 Mexico 11000 11000 10000 10000 Constant $ 9000 9000 8000 8000 7000 7000 6000 6000 5000 5000 4000 4000 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

GCC Countries Have Attempted to Diversify Their Economies • Development of petrochemical and metal industries bear little linkages to the rest of the economy • Promotion of services helped diversify economies but services may not be sufficient for sustainable growth – Focus on tourism, logistics, finance, etc. • Recent attempts at creating clusters, technology parks, and manufacturing industries in free zones have yet to yield substantial results

Standard Growth Policy Advice May Not Be Enough • The Gulf countries have had high rankings in infrastructure, doing business, competitiveness, and trade barriers indicators, but sustained growth per capita has not materialized • Standard growth policy advice may not be sufficient – it includes macroeconomic stability, minimum state intervention and an enabling environment conducive to investment in both physical and human capital

Tackling “Government Failures” I Doing Business vs. Global Competitiveness Index, 2013 Singapore 0 Saudi Arabia U.A.E 20 (Ranking among 183 countries) 40 Bahrain Oman Ease of Doing Business Qatar 60 80 100 Kuwait 120 140 160 180 200 140 120 100 80 60 40 20 0 Global Competitiveness Index (Ranking among 134 countries)

Tackling “Government Failures” II Quality of Infrastructure, 2013 (Score of 7 "meets the highest standards in the world") 7 U.A.E. 6 Bahrain Qatar Saudi Arabia 5 USA Kuwait Score 4 3 2 1 $500 $5,000 $50,000 GDP per capita

Tackling “Government Failures” III Monopoly Related Indicators (Rank 1 - 142, the lower rank the better) 180 180 Local competition intensity Prevalence of trade barriers 140 140 100 100 60 60 20 20 Bahrain Kuwait Oman Qatar Saudi U.A.E. Chile Malaysia Mexico Indonesia Norway Arabia -20 -20 Sources: The World Economic Forum's Global Competitiveness Indicators (2013-14).

Tackling “Government Failures” IV Burden of customs procedures 100 100 90 90 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 Bahrain Kuwait Oman Qatar Saudi U.A.E. Chile Malaysia Mexico Indonesia Norway Arabia Source: The World Economic Forum's Global Competitiveness Indicators (2013-14).

Norway: Falling Prey to Dutch Disease • In 2012, manufacturing hourly wages were the highest in the world and about double that of the US or Japan • Unit labor costs increased by 50 percent in the 2000s, whereas they declined in Germany and Sweden • Annual average hours per worker declined by 600 hours since 1960 to about 1400 hours in 2012, third lowest in OECD

The Norwegian Disease: Norway Experienced Decline in Export Sophistication Goods Export Sophistication, 1976-2006 16000 16000 Canada Denmark Malaysia Norway 14000 14000 12000 12000 10000 10000 8000 8000 6000 6000 4000 4000 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

Breaking the Oil Spell • High scores in infrastructure quality and other business quality indicators in the GCC are better than in successful oil exporters • Norway could not escape Dutch disease although government failures are basically nonexistent there • Firms choose to produce non-tradables over tradables because of risk-return trade-off largely favoring non-tradables • The standard growth recipe consists in tackling “government failures” rather than “market failures” • Diversification requires the leading hand of the state to create a dynamic export sector

Non-Oil GDP is a Misleading Indicator Bahrain - GDP by Sector, 1990 – 2011 Singapore - GDP by Sector, 1990 – 2011 (Share of total) (Share of total) 120 120 120 120 Agriculture Construction Transport Agriculture Construction Transport Trade Manufacturing Mining Trade Manufacturing Mining Other Other 100 100 100 100 80 80 80 80 60 60 60 60 40 40 40 40 20 20 20 20 0 0 0 0 1990 1993 1996 1999 2002 2005 2008 2011 1990 1993 1996 1999 2002 2005 2008 2011

It Is All About Exports Bahrain, Top 50 Exports of Goods, 2008 Singapore Exports by Sector, 2008 (Percent of total exports of goods) (Percent of total exports of goods) Oil 1.1% 0.8% 1% 1.5% 1.3% Oil exports 6.2% Food 24% Aluminum 9.9% Crude Materials Other Metals 79.1% Chemical Chemical products 2% Manufactured Food 1% Goods Processing Machinery & 10% Textiles Transport Equipment 51% Other Light Others Industry 11%

Creating a Dynamic Export Sector • Export orientation vs. import substitution/non-tradables • Domestic capabilities vs. portfolio diversification (e.g. Norway in the 1970s vs. petrochemicals/metals) • Sophisticated exports vs. agriculture and services such as tourism and finance • Beyond vs. within comparative advantage (e.g. Korea/Malaysia vs. Chile)

Changing Incentives for Firms • Promoting and supporting exporters, e.g. policies for small and medium enterprises (SMEs) • Using development banks, venture capital funds, and export promotion agencies (e.g. Brazilian Development Bank and SBIR in the U.S.) • Creating industry clusters with links to universities, special economic zones, start-up incubators, and research and development centers (e.g. Singapore) • Investing in purpose-specific skills and infrastructure • Providing a strict accountability framework for industries and firms receiving support (e.g. Korea)

Changing Incentives for Workers • Reforming the public sector from its role as the “employer of first resort” with generous transfers, pensions, and subsidies • Improving education quality through early childhood programs, teacher quality enhancement programs, and training institutes and technical schools • Changing social attitudes through “ Saemaul Undong ” -type social development program – The Saemaul Undong “…was in a sense, a movement for spiritual reform of Korean people, and has achieved a lot in this respect. It changed people’s attitude from laziness to diligence, from dependence to self-reliance, and from individual selfishness to cooperation with others.” ( Choe 2005)

Creating Winners • The key is the development of domestic exporters and local technology in sophisticated industries early on • Picking sectors rather than firms while preserving competition and “creative destruction” • Enforcing market discipline and accountability is important but difficult • The main challenge is to fix incentives for firms and workers, including social incentives • Learning “piecemeal” from each other while on the path to diversification

Creativity always comes as a surprise to us; therefore we can never count on it and we dare not believe in it until it has happened. In other words, we would not consciously engage upon tasks whose success clearly requires that creativity be forthcoming. Albert Hirschman “The Principle of the Hiding Hand”