Tough decisions must be taken to diversify the oil economies

Norwegian prime minister Erna Solberg has been leading efforts to gradually diversify her country from oil and gas production. Justin Tallis / AFP

In November 2013, Norway's prime minister, Erna Solberg, said that "We have to prepare Norway for an economy that [has] less oil income, directly, and less oil activity … That's a 20-year perspective, not a four-month perspective." The Nordic country, where crude and natural gas accounted for 41 per cent of exports in the second quarter, gets about 25 per cent of its total economic output from oil and gas.

As Norway has worried for some time about its diversification, so have the GCC countries, especially since the collapse of oil prices in 2014. The difference is that in the GCC, the 20-year perspective on diversification is more about creating the right preconditions than it is about opening the taps of government spending.

In Norway, to promote a more diverse economy, Ms Solberg’s Conservative Party has so far focused on cutting taxes and boosting public spending. The government of Norway plans to withdraw money for a second consecutive year from its US$880 billion wealth fund and spend 226bn krone (Dh97.64bn) of its oil revenue, equal to almost 8 per cent of the economy. General government spending is already topping 50 per cent of GDP, a level not reached in 20 years.

Meanwhile the GCC economies, to achieve economic diversification, should continue to strengthen macroeconomic stability and improve regulatory and institutional frameworks. These preconditions to diversification will make markets more flexible and competitive to spur the innovation for goods, services and job creation. Transitioning to a diversified economy with robust and nimble tradable sectors requires additional policies and strategies to develop local technological capability, promote the processing of natural resources, improve the competitiveness of non-oil exports and broaden the export base through integration into global value chains to encompass higher value-added activities.

Attracting foreign direct investment (FDI) in the non-oil sector would support a wider economic growth model. The oil and gas sector has been the largest beneficiary of FDI in most GCC countries. In Oman, for example, about 50 per cent of FDI is invested in the oil sector. As manufacturing and service export bases remain limited in many of these countries, specialisation and entrances in a specific segment of a global production chain could also benefit from FDI while improving export quality and sophistication, and accelerating technology and knowledge transfers, specifically in the form of FDI.

Improving the climate for foreign investment in non-oil industry may involve lowering entry requirements, creating investment promotion intermediaries and streamlining tax structures. For instance, some countries impose a requirement of a majority domestic ownership that is a deterrent to FDI and should be eliminated or at least limited to strategic sectors.

The UAE on January 10 announced plans to invest Dh600bn in projects to generate almost half the country's power needs from renewables. The UAE is a top oil exporter but has taken steps to reduce its dependency on fossil fuels to generate power, including building nuclear facilities. The country's energy mix by 2050 will comprise 44 per cent from renewables, 38 per cent from gas, 12 per cent from clean fossils and 6 per cent from nuclear energy, said Sheikh Mohammed bin Rashid, Vice President and Ruler of Dubai. The plan aims to increase usage efficiency by 40 per cent and increase clean-energy contributions to 50 per cent. Such plans should allow not only for energy diversification but FDI that can act as a lever of foreign investment attractiveness, value-added production options and growth.

Global Value Chains (GVC) are an additional mechanism through which firms in the GCC could access the world market and technologies. There is scope to join networks of supply chains and specialise at certain stages of the production of complex economic goods.

Many GCC economies still find themselves at the beginning of the process of integrating into global value chains. With exports dominated by oil, the share of foreign value added in exports remains significantly low. Moreover, the depth of integration in global value chains and/or the speed at which oil exporting countries (with hydrocarbon exports greater than 25 per cent of total exports) join networks of supply chains is relatively lower.

Further integrating global value-added chains would require deep exploitation of comparative advantage – including geographic position and labour intensity – improvement in technological capacity, greater efficiency in production, higher technical and managerial skills and competitive wages.

The activities along GVCs may involve concept, design, production, marketing, distribution, retailing and R&D and they might even include waste management and recycling. Depending on the industry needs, each link of the chain performs an activity and different firms add value at each stage of the production or service process. New transport, information and communication technologies have driven down the cost of accessing information and trading products and services and facilitate the spatial division of value chains. Accordingly, a certain production process can be in a particular geographical area because of the location’s competitive advantages. Among the economic determinants triggering the development of GVCs in developing countries, access to natural resources such as oil, mining and agriculture products is paramount.

Additionally, several low-cost locations have integrated into GVCs in selected labour-intensive industries. In Asia, because of the possession of certain specialised skills and trained -human resources, IT firms in India and electronics firms in China, Taiwan, Malaysia and Singapore have successfully integrated into GVCs. Similarly, but to a lesser extent, in Latin America the existence of a cluster of competitive suppliers made it possible for domestic suppliers of automotive parts and components in Argentina and Brazil and electronics components in Mexico to become first-tier suppliers in GVCs. GCC economies have to actively continue to consider how they can be integrated to the wider GVC product umbrella.

Norway and other resource-dependent economies know that ending a dependency is difficult, particularly when the benefits are immediate and the damage long term. But the tough decisions have to be taken now.

John Sfakianakis is the director of economic research at the Gulf Research Centre in Riyadh.

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