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Jul 13, 2015 | 09:19 GMT

How the Gulf Built Its Wealth

The Gulf Cooperation Council states of Saudi Arabia, Kuwait, the United Arab Emirates, Bahrain, Qatar and Oman face daunting economic challenges.
Editor’s Note

This is the first installment of a three-part series exploring the economic challenges faced by the Gulf Cooperation Council states: Saudi Arabia, Kuwait, the United Arab Emirates, Bahrain, Qatar and Oman.

The foundation of modern Gulf Arab power is hydrocarbon wealth. Led by Saudi Arabia, the Gulf states have used energy revenue to overcome the limitations imposed by their desert geography to emerge as a regional power bloc able to compete for hegemony with Turkey and Iran. Energy revenue, however, is fickle and the wealth it has created is not guaranteed in perpetuity. Because of this, the Gulf monarchies worked to diversify their economies to become less dependent on energy exports. This has been difficult. Geographic, demographic and political constraints have posed major challenges to these efforts. At the same time, lack of diversification poses long-term threats to Gulf economic and social stability — something that each member government is acutely aware of.

Now the Gulf monarchies face a potential extended downturn in global oil prices coupled with the effects of years of high state spending. This has made them increasingly vocal about adopting changes to domestic policy and adjusting budgets to match the evolving economic realities. Yet, the states within the bloc possess considerable financial reserves relative to the size of their populations and overall economies. In spite of this leeway, the Gulf monarchies will each embark on their own slow, managed reform process in the coming years while their balance sheets reflect a strong economic footing to minimize risks to their carefully cultivated social order and stability.

Historically, the Arabian Peninsula was one of the world's most resource-poor and underdeveloped regions.

Historically, the Arabian Peninsula was one of the world's most resource-poor and underdeveloped regions. Lacking the waters that provided fertility to the Nile Basin and Mesopotamia or a coveted position along the Mediterranean coast, the peninsula remained a bystander on the sidelines of events developing in Egypt, Turkey, the Levant or Iran. Economic activity was largely confined to subsistence farming or herding activities before the discovery and export of oil in the early 20th century, though small populations along the coastline of the Persian Gulf participated in pearl diving and limited trade with foreign powers. The hajj pilgrimage to the holy cities at Mecca and Medina has traditionally been a key catalyst of economic activity in Saudi Arabia and even today is one of the largest sources of employment.

The discovery of oil on the Arabian side of the Persian Gulf coincided with the consolidation of tribes and the establishment of the Kingdom of Saudi Arabia in 1932. By the 1950s, Saudi Arabia had started commercial oil sales. Discoveries in neighboring Bahrain, the United Arab Emirates and Kuwait continued through the 1950s. Development of the Gulf economies progressed rapidly following the independence of the emirates from the United Kingdom and because of rising oil output. Kuwait left the protectorate in 1961 and Bahrain, Qatar and the United Arab Emirates gained independence in 1971. Following the sharp rise in global oil prices after the 1973 oil crisis, the Gulf economies experienced some of the highest growth rates in their modern history.

Gulf Cooperation Council central bank reserves by country

The ensuing decades saw boom and bust cycles, coupled with significant changes in the surrounding region. The formation of the Gulf Cooperation Council following the Iranian Revolution, the backing of Saddam Hussein in the Iran-Iraq War and the 1991 invasion of Kuwait all served as important lessons for the Gulf States. Since the extended low oil prices of the 1980s, the Gulf monarchies, particularly Saudi Arabia, have spent the subsequent periods of higher oil prices paying off external debts and increasing investments to help hedge against periods of lower commodity prices.

The Limits of Economic Protectionism

There are limits to the abilities of individual states to insulate their economies. Success has depended primarily on their oil reserves and export levels. There is a key divide between oil-rich Saudi Arabia, Kuwait and the United Arab Emirates on one hand, and the relatively oil poor Bahrain, Qatar and Oman on the other. Qatar's economic fortunes improved dramatically following the development of its natural gas and liquefied natural gas production capabilities in the first decade of the 21st century, but Doha was forced to take on considerable external debt relative to its peers to finance infrastructure development.

Gulf Cooperation Council debt by country

Declining oil production has left Bahrain largely dependent on financial assistance from Saudi Arabia, though it has also worked to transform itself as a financial and banking center for the region. It has also invested in tourism and some heavy industries (particularly aluminum processing). Bahrain's diversification attempts have served as a model for the emirate of Dubai, whose own declining oil reserves prompted a series of investments into real estate development, finance, tourism and manufacturing. Oil, however, is still the lifeblood of the Gulf economies. For example, following the downturn in Dubai's fortunes amid the 2008-2009 global economic crisis, and rising instability in Bahrain and Oman during the 2011 Arab Uprisings, the wealthier oil-exporting economies of the GCC (Saudi Arabia, Kuwait, and Abu Dhabi) bailed out their neighbors, helping to maintain stability.

Persian Gulf oil production by country

Gulf leaders recognize that the relatively short period of rapid wealth accumulation and ensuing economic development is nearing its end. Their ability to adjust national policy, however, is constrained by geography and growing concerns over social stability. With petrodollars at the core of Gulf Arab power, governments have had to spend during periods of high oil prices to accumulate military equipment, placate growing domestic populations, and invest in power, refinery and desalination infrastructure to offset the challenges of their largely desert geography. The monarchies have shown several times in the past that they are able to adapt and to enact changes when faced with a combination of lower energy prices and regional threats. With current oil prices about 50 percent lower than this time last year, and with an emerging U.S.-Iran rapprochement, the Gulf monarchies led by Saudi Arabia are again approaching a period of necessary reforms to adjust to their rapidly changing environment.

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