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Saudi Arabia
Economic Policy During the Oil Boom, 1974-85
In the early 1970s, the economic situation changed dramatically.
Oil exports expanded substantially, royalty payments and taxes
on foreign oil companies increased sharply, and oil-exporting
governments, including the kingdom, began setting and raising
oil export prices. Saudi Arabia's revenues per barrel of oil (averaged
from total production and oil revenues) quadrupled from US$0.22
in 1948 to US$0.89 in 1970. By 1973, the price had reached US$1.56
and soared to US$10 and higher in 1974 following the Arab oil
embargo introduced to pressure Western supporters of Israel during
the October 1973 War. In 1982 the average export price per barrel
of oil reached well above US$30. Between 1973 and 1980, government
oil revenues jumped from US$4.3 billion to US$101.8 billion. At
last the higher oil revenues gave Saudi officials the means to
make major structural changes in the economy.
The society encompassed factions eager to promote the modernization
program, as well as some elements within the royal family and
the religious community who feared the social consequences of
rapid economic transformation. Others, mainly from the technocratic
elite, were concerned about the economic consequences of such
a rapid expansion in expenditures. One choice facing policymakers
in the early 1970s was whether to restrict oil production to a
level that was adequate to finance limited economic and social
development or to allow production at a level that would meet
world demand for crude oil. Choosing a relatively high production
level would force a decision on whether to use resulting revenues
for rapid domestic economic and social development or long-term
investments abroad. There were other policy choices. Those people
who wanted to keep oil in the ground, except for that needed for
limited development, argued strongly that this policy would best
preserve the country's resources for future generations.
The choices appear to have been made by 1974 at the latest, although
the decision-making process was not always clear or discernible.
One issue was clear, however: domestic economic policy did not
drive oil production and export policies. The Al Saud pledged
to keep oil flowing at moderate prices, commensurate with world
needs, arguing that the kingdom was as dependent on the stability
and prosperity of consuming nations as those nations were on Saudi
oil. Moreover, if Saudi Arabia wanted to ensure that oil would
remain the energy source of choice, moderate prices were essential.
In addition to framing the issue in purely economic terms, the
decision had a geopolitical dimension: since World War II the
kingdom had linked itself with the West and was eager to honor
its pledge as a loyal ally on the international and regional level.
This position was also reflected in its relations with Aramco.
Saudi officials argued that the kingdom had avoided nationalization,
opting instead for a gradual takeover of foreign oil companies
operating within Saudi borders. Despite these attempts to moderate
oil prices, the supply-and-demand fundamentals of the international
oil market combined with the changes in ownership of downstream
assets to raise international oil prices, creating enormous pressures
on the domestic front to invest rising oil revenues in developing
the country's economic and social infrastructure.
By the mid-1970s, the government had decided to use most of the
growing oil revenues for a massive development effort. An important
part of that effort was to industrialize, largely by investing
in processing plants that used the country's hydrocarbon resources.
This policy meant at least a decade of very large investments
to build the plants and the necessary infrastructure. It meant
financing and building the gas-gathering system, the pipelines
for gas and crude oil to bring the raw material to the two chosen
main industrial sites--Al Jubayl (or Jubail) and Yanbu al Bahr
(known as Yanbu)--and building the industrial sites themselves.
The development effort also included many other projects, such
as the huge and costly airports at Riyadh and Jiddah, hospitals,
schools, industrial and plants, roads and ports. By the mid-1980s
the massive expenditures totaled US$500 billion.
The decision to increase the country's oil and gas resource development
through downstream investments in refineries and petrochemical
plants was logical considering the country's resource endowment.
Three factors motivated such a strategy. First, downstream investments
were capital-intensive, which fitted Saudi Arabia's small population
and large oil revenues. Second, more value-added income would
be extracted and retained, thereby maximizing Saudi revenues through
the export of more refined petroleum products instead of crude
oil. Moreover, the natural gas that had been largely wasted before
the 1980s would be processed and used.
Third, some Saudi planners saw industrialization as another opportunity
to widen the sphere of economic activity for foreign and domestic
private firms. Participation of foreign private sector firms was
crucial from the outset. Saudi Arabia invited several international
oil companies to invest in joint ventures in the new export refineries
built in the kingdom during the late 1970s and early 1980s. Furthermore,
participation by international petrochemical companies was necessary
to obtain the technology needed. There was also the issue of access
to the markets of the West: Saudi planners anticipated regulatory
and trade problems by exporting petrochemicals to markets that
already had made substantial investments in the petrochemical
industry. Saudi planners therefore hoped that, with the help of
foreign multinationals, they could fit Saudi petrochemical output
into international distribution networks.
On the domestic front, the state would build the basic industries,
the crucial first step in the chain of industrial processing.
Through loans and other incentives, the state would foster the
growth of specific private sector industries that would be at
the lower end of the industrial process. Over a period, the planners
anticipated that the state-owned conglomerates might be partially
privatized.
A large part of the funds spent on development programs were
intended to promote private sector investment and to support future
consumption. Starting in the mid-1970s, the government decided
that an adequate infrastructure was essential to the kingdom's
future development. Providing this infrastructure included revamping
and building electricity, water, sewerage, desalination, and telecommunication
systems. Moreover, it entailed creating airports and ports and
laying a vast network of roads. In terms of generating and distributing
electric power, the government assisted private companies building
and operating its electricity network through concessionary capital
loans and continuing operating subsidies. Apart from upgrading
distribution facilities for water, the government built several
desalination plants and drilled wells, built dams, and installed
pumps. Telecommunications were quickly brought to international
standards, allowing Saudi Arabia to handle all its communication
needs in local and international telephone, telegraph, maritime,
and television distribution services, via cable, satellite, and
terrestrial transmission systems. Under King Faisal ibn Abd al
Aziz Al Saud (1964-75), there was a massive increase in government
spending on education to an annual level of about 10 percent of
the budget.
Saudi planners also saw the need for a subsidy program to supplement
direct government outlays. The major reason was income distribution.
Although direct grants to average citizens would have been most
efficient, the logistics involved would have been difficult. Conversely,
waiting for the oil expenditures to reach this economic and social
objective might have created additional social tensions. Therefore,
the government adopted a widespread subsidy program for utilities,
fuels, agriculture, social services (both private and public),
the industrial sector, and several other areas. Beyond income
distribution, the rationale of the subsidy program was the need
to promote nonoil development through cheap loans, technical assistance,
industrial and agricultural incentives, and preferential buying
of domestic products by the government. The subsidy program was
also designed to improve education and health services.
The massive development effort entailed many risks. The size
of the effort and the technology involved required the participation
of a huge number of foreign workers for a long period, with the
potential of disrupting the society. The pace of modernization
was also economically disruptive. Some observers questioned whether
Saudi refineries and petrochemical plants would be efficiently
managed and prove competitive within a reasonable time. By the
early 1980s, the country encountered economic and social tensions--such
as the inflation of the mid- 1970s, the takeover of the Grand
Mosque in Mecca in November 1979, and disturbances in the Eastern
Province in 1979-80--that dissipated only late in the 1980s.
Another risk of the massive development effort was the loss of
control over expenditures or inadequate justification of investments.
The sudden easing of financial constraints in the mid-1970s permitted
consideration of projects too lavish or too large earlier. The
forced development of the capital at Riyadh was a sentimental
and political decision that required large expenditures to bring
such necessities as water, electricity, communications, and housing
inland to a capital far from the economic centers of the country.
The huge airports at Riyadh and Jiddah (built at a reported cost
of US$3.2 billion and more than US$5 billion, respectively) were
architectural monuments, but whether they were a wise use of the
patrimony of future generations was unclear.
The rapid rise of public purchases and contracts after 1974 caused
foreign businessmen to flock to the kingdom. Because Saudi agents
were usually essential, foreign businessmen frequently paid them
large fees, to be recovered in the contract they were seeking.
The Saudi business sector viewed these practices from a perspective
different from that of some outside observers: agent fees and
influence peddling were called corruption by visiting journalists
but were judged less harshly domestically, although there was
some unease. Some Saudis criticized agent fees frequently granted
to the wealthy, especially people related to the royal family.
The perceived costs, combined with growing criticism at home,
eventually prompted the government to restrict the use of agents
and fees on some defense contracts and to take other measures
to control costs.
Looking back at this huge effort in the early 1990s after several
years of stagnant public investment, the picture was mixed. On
the one hand, the infrastructure had stood the test of time and
provided the citizenry with world-class facilities. On the other
hand, maintaining these investments, some of which lacked a direct
financial payback, despite their more general economic uses, has
been costly. More problematic may be the public perception that
authorities, having fostered such dependency on government largess,
found it extremely difficult to reduce services.
Several other infrastructure problems became apparent. First,
the vast majority of expenditures were concentrated in a few cities,
predisposing these metropolitan areas to more rapid economic growth.
Second, infrastructural support systems were programmed at an
early stage of the country's development, rendering some obsolete
in the early 1990s. Third, some of the facilities seemed to have
been built as an end in themselves, leading to unnecessary waste
and continuing maintenance costs.
The most entrenched problem from the period of rapid development
of the mid-1970s to the early 1980s stemmed from the government's
willingness to subsidize production, consumption, and investment.
The objectives for subsidies were threefold: encouraging nonoil
economic activity, meeting social goals, and distributing income.
The subsidy program may have created greater problems than were
earlier anticipated. Saudi planners never thought that oil revenues
would constrain expenditures to the extent that they did in the
late 1980s and early 1990s. Efficiency requires that subsidies
be applied directly at the source. Most Saudi production subsidies
have been indirect subsidies, which have reduced the cost to consumers
of electricity and other industrial inputs, leading to unnecessary
waste. The industrial sector has thereby become a relatively inefficient
producer and has made little effort to wean itself from government
assistance.
Nowhere was this problem more prevalent than in the agricultural
sector where national security was the original objective in raising
output. Saudi Arabia became self-sufficient in several major food
grains but the cost to the budget and the ecology could not be
justified. First, international experience has shown that food
embargoes have generally failed unless accompanied by a major
military campaign. Second, savings on food purchased from overseas
could easily have been invested in inventory to safeguard against
an external threat. Third, no social benefit emanated from such
a program. Agricultural employment continued to decline, and large
conglomerates, rather than peasant farmers, profited from most
subsidies. Fourth, subsidies could have been related to more appropriate
production methods that promoted water conservation.
Data as of December 1992
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