Dutch Disease in Saudi Arabia

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Having abundant natural resources can either bring blessings or curses. It can be viewed as a blessing because, the discovery of these resources or an augmented worldwide market value of the same, increases a country’s income generation, and thus the expenditure possibilities of that economy are also increased. Conversely, it is a curse because it can bring about the Dutch Disease which in turn, has harsh economic impacts in the short and long run while acting as a hindrance to development in the particular nation. However, in the end, everything depends on how revenue from these resources was used. Spending and managing huge revenues wisely are always more complex than they may initially appear. There are infinite approaches to spending and managing them, although there is no consistent answer to curing the Dutch Disease if it infects a particular country.

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The Dutch Disease theory came into being in the Netherlands following the countries discovery of vast natural gas resources in the North Sea early in the 1960s. “As a result of the large capital inflows, which followed from increased export revenues, the demand for the Dutch florin increased which in turn resulted in an appreciation of the Dutch exchange rate” (Rodriguez, 2006). This was seen to bring about great difficulties on the economy, and especially on Dutch manufactured commodities to compete on the world market. Therefore, this paper intends to increase understanding about the Dutch Disease focusing particularly on oil-rich Saudi Arabia.

The theory of this disease is still relevant to date as it is continuously affecting nations all over the globe. With the currently rising global market prices for raw materials, countries are still prone to the disease. In the economy, this theory is currently being used to explain negative effects from capital inflow caused for example, by aid remittances, and beneficial terms of trade shocks or sharp productivity increases in export production.

In the context of Saudi Arabia, “the country happens to be the world’s largest oil exporter. This means that a great part of its economy depends heavily on oil. The dependency on oil has a lot of implications politically and economically on the country” (Eden, 2000). In Saudi Arabia, oil was discovered around 1938. Initially, the nation was split up into several sections, depriving livelihoods of particular resources and activities. These areas formed one kingdom discovering oil 6 years later. The resource led to an economic transformation in the kingdom. At first revenues from these resources were kept by the royal family. “Saudis have a belief that the king has the overall authority. Politics, labor unions and political parties are outlawed hence their government is accountable to itself” (Eden, 2000). The country started recording increased revenues in the 1970s, its government at the outset, tried to hold back the mining of oil for ensuring long-lasting proceeds; but the rising global demand compelled them to bring another strategy onboard. They ventured into industrial development processing hydrocarbons to steer their economic growth. Therefore, the first consideration we can come up with when looking for Dutch Disease is the heavy oil reliance displayed by Saudi Arabia.

In Saudi Arabia, the symptoms of this disease need to be diagnosed in diverse aspects of its economy. The initial area of diagnosis is on oil reliance, the next possible area is the real exchange rate, inflation, the labor sector, in manufacturing, in the infrastructure, in its industries, and agriculture. These sectors are supposed to be scrutinized by employing the Dutch Disease theory and finding out what has happened in the sectors.

When focusing on oil dependency, we find that “oil-induced Dutch Disease assumes an oil sector which largely contributes to the economy. In the case of Saudi Arabia, this is undeniably true” (Eden, 2000). In this case, oil discovery in 1938 initiated an extensive economic change rising the revenues of the nation. This nation is by far the leading oil producer worldwide; it has also played significant roles in industrializing the world due to its stable oil flow important for intercontinental economic stability. The nation due to its excess oil capacities, especially after the Gulf War, has the strongest manipulation power on prices and supply.

After the increment of oil exports in the 70s, “Saudi Arabia’s revenues per barrel quadrupled. By 1982 its revenues had risen from US$4.3 billion to US$ 101.8 billion. This is when Saudi officials finally obtained the means to make major structural changes in the economy” (Bahman-Oskooee, 2001). Currently, the nation is the biggest producer of crude oil relying heavily on these revenues. In 2004 for example, “oil revenues made up 85% of their entire revenues, and about 46 percent of GDP. Oil export revenues, of which a large portion is allocated to the budget, accounted for 88% of total exports” (Corden & Neary, 2002).

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On real exchange rates, this disease indeed forecasts its appreciation as an impact of capital inflow on a resource boom. According to the Saudi Arabian real exchange rating, we can easily deduce if the symptoms of this disease are present. Even when information on price developments of tradable and nontradable commodities is not presented, there are other methods of knowing real exchange-rate developments. One of these is the real-effective exchange rate. The annual-real-average exchange rate for Saudi Arabia appreciated from 1973 to 1976 then depreciated from 1977-1980. Following increased economic activities an appreciation was realized up to 1984 where yet another depreciation followed.

High inflation rates are associated with Dutch Disease infected nations. The reasons for inflation, are widespread and do not necessarily depend on capital inflows. On the other hand, capital inflow augments monetary supply and thus creates inflation because extra money increases demand and consequently the prices. In our case, structural aspects did contribute significantly to the rising inflation. “However, the main factor responsible for inflation in the 1970s was increased liquidity which resulted from the increase in oil revenues after the first oil shock” (Bahman-Oskooee, 2001). The liquidity was inserted into the economy to fund economic development.

Manufacturing sectors, on the other hand, are expected to turn down by the Dutch Disease theory, as real exchange rates appreciation makes local manufactures more costly than foreign ones. In our case, this sector was diminutive before the initial oil boom. Local manufacturing expanded after revenues started flowing in meaning the country had acquired means to develop the sector.

The Dutch Disease theory shows a likelihood of declined agricultural activities since labor often shifts from this area to the booming sector. In Saudi Arabia labor from this sector decreased but still, the country had policies in place to guard it against food insecurity. Following key subsidies, agricultural production in this country increased.

The expenditure and resource shift effects foretell shifts in the labor force between sectors. “The former effect expects labor to some extent to be attracted from the tradable sector to the non-tradable sector, whereas the latter effect predicts labor to be attracted from the lagging and the non-tradable sectors into the booming energy sector” (Corden & Neary, 2002). In the event of overheated labor markets having extreme demand for employment foreign labor will be required. This was the case in Saudi Arabia. To some extent, this helped to moderate the Dutch Disease as without foreign labor the value of nontradable commodities would have increased as a result of the lack of labor in the sector.

Like any other country that discovers natural resources bringing in huge revenues, efforts will be made to develop the economy and industrialize the nation. This was the case of Saudi Arabia which used oil revenues in its bid to develop the country. Because of this bid, an enormous flood of importation was realized too big for the transport system to handle. “The ports were clogged with ships which had to wait for months to unload. Storage and distribution became inadequate; there was an acute housing shortage, skyrocketing construction costs, and a growing manpower shortage” (Rodriguez, 2006). This condition caused prices to soar by about 50% in a year. Therefore in Saudi Arabia, oil resources facilitated industrialization and development efforts.

As shown in this paper, Saudi Arabia looks like it possesses the required prerequisites for Dutch Disease. It is also clear that Saudi Arabia being the biggest crude-oil producer, the resource is what contributes extensively to the economy. It is also true that the country is largely reliant on oil revenue, as it constitutes the most important portion of governmental revenues. “The massive inflow of liquidity, following the increase in oil revenues, resulted in high inflation, especially during the first part of the 1970s, as well as changes to the real effective exchange rate” (Rodriguez, 2006). Additionally, the oil boom brought about overheated labor markets needing a lot of foreign employment and an increase of the nontradable sector. To this point, all facts tend to favor the symptoms of the Dutch Disease.

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The Dutch Disease theory has its associated difficulties, especially if no counter-measures are implemented following huge capital inflows. In this nation, however, there were early policy implementations that, cushioned the country against the problems, even before the initial oil boom. The negative effects that were realized were bottlenecks in production, housing shortages, and increased prices. Conversely, the implemented policies plus the developmental efforts helped in establishing hydrocarbon production, and therefore working towards diversifying the economy. This is what disallowed a lot of Dutch Disease-related problems from arising.

References

Bahman-Oskooee, M. (2001). Oil Revenues and the Saudi Arabian Economy. Applied Economics, 35 (1), 437-448.

Corden, M., & Neary, J.P. (2002). Booming sector and De-industrialization in a small open economy. Economy Journal, 92 (5), 825-848.

Eden, D.G. (2000). Oil and Development in the Middle East. New York, NY. Praeger.

Rodriguez, C. (2006). Dutch Disease in Saudi Arabia. Lund: Lund university press.

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BusinessEssay. (2021) 'Dutch Disease in Saudi Arabia'. 8 December.

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BusinessEssay. 2021. "Dutch Disease in Saudi Arabia." December 8, 2021. https://business-essay.com/dutch-disease-in-saudi-arabia/.

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