Can Saudi Arabia diversify its economy without an Aramco IPO?
Few challenges are more existential for Saudi Arabia than the need to wean its economy away from an excessive dependence on oil. The country faces two certainties on the external and domestic fronts: the excessive volatility of oil markets with its attendant consequences on the national budget and a growingly young and educated labour force (more than 50 percent of Saudis are below 25 years of age).
Saudi Arabia has traditionally bought social peace by distributing rents to its citizens through salaries, subsidies, and other welfare instruments. This social pact has become increasingly precarious in the midst of fluctuating oil revenues and expanding expenditure commitments at home.
It is in this context that Saudi Arabia’s Vision 2030 was hailed as a reformist intent, signalling a transformative move towards a post-oil future. A key plank of this strategy was the partial privatisation of Saudi Aramco through an initial public offering (IPO) of around 5 percent of its share in global markets. When the Saudi king recently pulled the plug on this international listing of Aramco, observers have started wondering about the fate of diversification.
Is there still hope for diversification after a central pillar of the Vision 2030 has fallen through? And, is Saudi Crown Prince Mohammed bin Salman’s grand vision still relevant and credible?
Diversifying without an Aramco IPO
The short answer is that it is still too early to write off the prospects for diversification in Saudi Arabia. Equally, diversification would have proven challenging, with or without the partial privatisation of Aramco.
Firstly, although Aramco’s listing in international stock markets has been called off, the national oil company is still planning to raise debt through its acquisition of a strategic stake in SABIC, the country’s petrochemical giant.
With its currently modest debt levels, Saudi Arabia should have little difficulty raising money through capital markets. The only difference would be that the cash would be raised in a roundabout way through bonds rather than equities.
Secondly, even if Aramco’s listing had gone ahead, it wouldn’t have solved Saudi Arabia’s diversification challenge on its own. While a centrepiece of Vision 2030 and despite all the fanfare on the original announcement, the Aramco listing would have only served as a wealth management strategy.
A helpful start, indeed. But diversification is a more serious and intricate development challenge in the context of Middle East’s oil exporters. Quick-fixes or stop-gap arrangements can only provide a temporary breather; they are no substitute for structural economic reforms.
To diversify its economy, Saudi Arabia would need a holistic development vision that recognises the fundamental inseparability of economics and politics.
Diversification is unlikely to result from a technical blueprint delivered by jazzy foreign consultants. For too long, the country has attempted to reform its economy in ways that neutralise the effect of such reform on politics. But the trouble is that any genuine shift in the country’s economic structure will produce political consequences, which neither the rulers nor the consultants they hire wish to confront.
For example, to develop a non-oil economy the regime will have to accommodate the prospect of a truly independent private sector, which can generate new pockets of economic influence whose power could spill over into the political domain.
It is precisely for this reason that authoritarian regimes in the Middle East are suspicious of outsized economic actors who could initiate political action.
This means that regimes only tolerate a private sector that is dependent and loyal. Firms recognise that the standard operating principle to survive (and thrive) is to partner with regime insiders either directly or through brokers and fixers.
The moment a business becomes successful or indicates a potential for growth, it is pressurised to “sell or go into partnership” with the regime’s frontmen. Firms thus face a binary option: partner or perish.
In this scenario, firms prefer to operate under the radar and avoid direct confrontation. When connections with the royal circle become the most valuable asset for firms, small young companies have poor prospects in the marketplace.
Challenges of private sector growth
It is little surprise, then, that the Saudi private sector is dominated by large established players or companies that are simply a front for powerful royals. And, it is usually these large connected conglomerates that benefit from state contacts through opaque procurement and licensing procedures.
With one of the largest construction industries in the Middle East, Saudi Arabia can unlock its economic potential through a systematic reform of this sector, which would involve making bidding procedures genuinely competitive.
Connected firms also have privileged access to the two essential inputs private firms need – land and credit. Small firms face huge difficulties in accessing land, especially in peri-urban spaces where powerful families tend to leave land parcels idle in anticipation of capital gains.
Until recently, arbitrary land confiscations by members of the royal family were a common occurrence. This land is sometimes sold back to the government for implementing public projects, generating a handsome rent for insiders.
Public land registries are notoriously under-developed. And, when it comes to accessing bank credit, small and medium enterprises (SMEs) face a systematic disadvantage, receiving only about two percent of total loans.
Difficulties in land ownership mean that these firms lack the requisite collateral needed to secure bank loans. With oil-induced uncertainty affecting bank lending and large exposures to a few connected borrowers, commercial banks have limited room or incentive to offer intermediate credit to SMEs, a segment of economy that is most deserving of such capital.
As if entry and survival in the market weren’t hard enough, SMEs also find it difficult to exit the market as insolvency is exceptionally hard to resolve in Saudi Arabia. On this account alone, Saudi Arabia ranks 168th out of 189 countries in the 2018 Doing Business report.
This does not bode well for the forces of creative destruction that define a dynamic firm space where firms can enter, compete, or exit according to the diktats of market competition.
In the midst of these structural barriers, diversification will remain a pipe dream.
The politics of diversifying an economy
To diversify, the Saudi government needs to introduce radical pro-competition reforms, make land markets more transparent, and de-couple markets from the stranglehold of connected actors and firms. However, any such reform is likely to have grave political consequences, since it will reduce or kill the rents that help to sustain the cooperation of royal elites and their influential business partners.
The larger point I thus wish to make is that a genuine economic open door (infitah) will create both winners and losers. In this context, diversification is not just about creating winners who have a vested stake in a reformed business environment; it also requires compensating losers who could potentially spoil reform efforts.
In East Asia, this was done by striking deals with rent-seeking groups who could throw spanner in the works. As famous economist Pranab Bardhan has argued, these deals were often backed by institutional arrangements to share rents with potential spoilers.
Such arrangements existed, for example, in Japan where potential spoilers in the Liberal Democratic Party were systematically bought off. In Malaysia, the Chinese business conglomerates brought prominent members of Malay political elites on company boards.
Extrapolating this to Saudi Arabia, could one imagine a bargain that keeps ruling clans out of business in exchange for higher royal stipends or in-kind rewards?
To do so, however, would require an active recognition of the political fallout of economic reform and the creation of new bargaining structures that could balance the interests of reformers and spoilers, and nudge the growth trajectory towards a higher equilibrium.
Had the political fallout of an Aramco listing been worked out before and the buy-in from relevant actors secured in advance, the devastating blow to the credibility of Vision 2030 could have been avoided.
After all, it was clear from the outset that the valuation of Aramco was hugely over-optimistic and that an international listing would necessitate a more transparent disclosure and an opening up of Aramco’s books, something that would face political resistance. In the end, politics trumped whatever economic rationale lay behind the proposed IPO.
Going forward, rather than relying on flashy, big bang approaches to diversification, Saudi policymakers need to adopt a more grounded and constructive strategy for economic reform that recognizes the centrality of politics.