Shantayanan Devarajan on "How the Arab World Can Benefit from Low Oil Prices"

Shantayanan Devarajan, Chief Economist of the World Bank’s Middle East and North Africa Region, delivered a CIRS Focused Discussion on “How the Arab World Can Benefit from Low Oil Prices” on March 24, 2016, in which he proposed that the widespread concern about plummeting oil prices, particularly among rentier states, is not a predicament to be solved, but an opportunity to be harnessed.

Devarajan highlighted four key problems facing the Arab world today. The first of these is that the region has the highest unemployment rates in the developing world, a figure that reflects the systematic exclusion of women and young people from the labor market. The second problem is the lack of economic diversification, and especially in the case of the Gulf Cooperation Council (GCC) states, concentration on the exports of a single commodity, whether oil or gas. Made more visible by the events of the Arab uprisings, the third problem includes the poor quality of public services, such as the widespread lack of sustained electricity and sanitation in many Arab countries. The final problem concerns the high volatility of already declining average growth rates for countries such as Egypt.

All of these issues, he argued, are intimately connected with the prevalent policies decision-makers have implemented across the Arab world in recent times. Devarajan identified and discussed three key adverse policies. The first concerns a variety of policies that have led to the non-optimal use of public resources, whether deliberately or inadvertently. The second adverse policy involves the high proportion of civil servants in the labor force, making the ratio of public to private sector workers in the MENA region the highest in the world. In Kuwait, for instance, 95 percent of the male labor force works in the public sector. Exemplifying the high levels of volatility in the region, the third policy underscores the pro-cyclical strategies that allow countries to enter into an expansionary mode when oil prices are up, often with the risk of debt, and contraction when prices drop.

Devarajan emphasized the connection between poor policymaking initiatives and the four major problems facing the Arab world. As an example, he examined the impact of fuel subsidies on energy-intensive industries, arguing that the persistent subsidizing of these large, old, and capital intensive firms hinders these small firms from growing, ultimately affecting the labor market and precluding employment growth. Young and small firms, on the other hand, which do create jobs through growth and expansion, are associated with non-energy-intensive firms. Thus, unemployment in many Arab countries can be partially, but not exclusively, attributed to energy subsidies. Similarly, the policy of Arab countries maintaining a large civil service has the effect of crowding out the private sector. The relatively more stable working conditions for those employed in the public sector, in both oil importing and exporting countries, discourages nationals from working in the private sector, thus limiting overall economic growth.

These examples, Devarajan noted, constitute the “bad news.” However, the “good news” has been steadily taking shape since the price of oil fell in 2014-15 when the region began witnessing remarkable systematic investments in energy subsidy reforms by oil importers and exporters alike. “The UAE, basically, has eliminated its fuel subsidies,” Kuwait, Morocco, Jordan, and Egypt have followed suit, and “Lebanon has addressed its water subsidies,” leading to a positive environment of policy reform. In the civil service sector of many Arab countries, partial reforms are being undertaken, where governments are cutting back on civil service wages, benefits, and wasteful expenditures. Underpublicized are also efforts by some of these countries to improve energy efficiency, including investing in renewables. Owing to recent subsidy reforms, and by association, the drop in oil prices, oil-dependent countries are unexpectedly moving towards renewables, even faster than some European countries, thus making a larger contribution to the mitigation of global climate change. In contrast to times of stability, therefore, low oil prices allow for the formation of political coalitions necessary to pursue a variety of political and economic reforms. The reason for these changes, Devarajan explained, is budgetary pressure. “It is actually the right thing to do even if there were no budgetary pressures. This is something that should have been done a long time ago if you wanted to solve these problems of unemployment and poor quality services.”

Even though Devarajan acknowledged many of the major advancements made, he said there remains much work to be done. He suggested further improvements that can be implemented, including a variety of public service reforms to overcome the “credibility trap” where mistrust of the government’s ability to improve public services paralyzes public contributions to financing those services. Further, the persistence of reactionary decisions and policies towards changes in oil prices underscores the necessity of adopting standardized fiscal rules to overcome obstacles to economic growth. Lastly, the civil service in oil-exporting countries, particularly those with small citizen populations such as Kuwait and the UAE, function as a system for redistributing oil revenues. “There is no reason to have 95 percent of the labor force in the civil service. There are not that many jobs. There is not that much work to be done in the public sector to have so many people employed,” he argued. Devarajan concluded by sharing his optimism for further positive change in a low oil-price Arab world due to already demonstrated possibilities for reform. 

Shantayanan Devarajan is the Chief Economist of the World Bank’s Middle East and North Africa Region. Since joining the World Bank in 1991, he has been a Principal Economist and Research Manager for Public Economics in the Development Research Group, and the Chief Economist of the Human Development Network, South Asia, and Africa Region. He was the director of the World Development Report 2004, Making Services Work for Poor People. Before 1991, he was on the faculty of Harvard University’s John F. Kennedy School of Government. The author or co-author of over 100 publications, Devarajan’s research covers public economics, trade policy, natural resources and the environment, and general equilibrium modeling of developing countries. Born in Sri Lanka, Devarajan received his B.A. in mathematics from Princeton University and his Ph.D. in economics from the University of California, Berkeley.

Article by Hazim Ali, Center for International and Regional Studies