Arab-Latin lessons on diversification

Diversification from oil could remain a pipe dream

This is not just because of geography but also because they are in some respects so similar. Their economies are, above all, just too reliant on exports of primary goods – not to each other but to Asia, Europe and the US.

Both regions have, nevertheless, played a vital and linked role in the globalization of finance, as well as goods, over the last five decades. Over 50 years, Euromoney has followed this every step of the way.

During the Arab Gulf’s first oil boom in the 1970s, petrodollar flows helped the budding international capital markets to flourish, as banks recycled much of the Middle East’s oil revenues into Latin American debt markets. How much good those flows have done to each region is a matter of debate, given the inconstancy of the Gulf’s oil flows and Latin Americas’ inability to manage those debts.

But today, once again, Latin America and the Gulf face similar challenges: how to boost growth and therefore jobs, at a time of lower commodity prices. Comparisons between the two regions are rare but, in this context, instructive.

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For Latin America, the lesson from the Gulf is that technocratic gradualism has its advantages. It has avoided the worst consequences of the kind of populism that Latin American democracy has spawned. Had it been more subject to such forces, Saudi Arabia might not have saved the currency reserves that (unlike Venezuela) it has been able to deploy to bolster its currency and budget after the 2014 oil price fall.

On the other hand, it is hard not to connect Latin America’s messy democracies with the relative vibrancy of its private sector – and, in turn, these states’ lesser dependence on commodity-export revenue.

Key economic difference

In parallel to their contrasting political freedoms, the key economic difference between these regions is in their degree of state control and, linked to that, their exchange rate policies. Over the last 25 years, Mexico and other commodity-rich Latin American countries have set a global standard for managing floating exchange rates in emerging markets. Gulf currencies’ enduring peg to the dollar, instead, offers stability but keeps non-oil exports uncompetitive even when – like now – oil prices are low.

Since the 1980s, Mexico has switched from oil to manufacturing exports to a much greater extent than most other oil-rich states and especially compared with the Gulf. There are, of course, many reasons for this, but it is hard to separate these regions’ economic diversification from the importance of governments to local corporate life and the dynamism of their small and medium-sized businesses.

SMEs are crucial for private-sector job creation. Yet, according to the IMF, SMEs only account for around 10% of bank lending in Latin America and about 5% or less in Saudi Arabia and the Gulf, compared with more than 15% in Asia.

The Gulf’s leaders are not doing enough to strengthen their institutions and legal rights

It seems extraordinary that access to credit should be the biggest barrier to startups in a region such as the Gulf, where the banks are so healthy. Despite high aspirations (because of high youth employment), successful new businesses are, however, rare in the Gulf because of poor contract enforceability, minority shareholder rights and especially access to credit, according to Brookings Institution Doha fellow Nader Kabbani.

The reason is that it is so much more attractive for banks to lend to the government, despite Gulf governments’ low borrowing costs. Also, there is so much opportunity to fund government-related credit there. Even the biggest private-sector companies often act primarily as government contractors. Public-sector employment and corporations that governments control are particularly important in the Gulf.

More state backing for SME lending and better bankruptcy laws could help the Gulf’s SMEs. But the experience of Latin America suggests that an economy less dependent on commodity exports will tend to go hand in hand with a more pluralistic society.

Wealth

Proportionate to its population, the Gulf has more wealth to invest in infrastructure and education. It has acted on the former advantage and there is some sign it is investing more in education, even for women. On the other hand, governments in the Gulf are dependent on the whims of authoritarian and male-led families. They are far less accountable to their people – especially women and immigrants – than in Latin America.

The Gulf’s leaders are not doing enough to strengthen their institutions and legal rights. If that does not improve, or even gets worse, it will be much harder to attract investment not just from abroad but also from local would-be entrepreneurs. In which case, diversification from oil will remain a pipe dream.

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