Economic Diversification

Transcription

1 by Rabih Abouchakra Chadi N. Moujaes Maze Ramsay Najjar Richard Shediac Ecoomic Diversificatio The Road to Sustaiable Developmet

2 Booz & Compay is a leadig global maagemet cosultig firm, helpig the world s top busiesses, govermets, ad orgaizatios. Our fouder, Edwi Booz, defied the professio whe he established the first maagemet cosultig firm i Today, with more tha 3,300 people i 57 offices aroud the world, we brig foresight ad kowledge, deep fuctioal expertise, ad a practical approach to buildig capabilities ad deliverig real impact. We work closely with our cliets to create ad deliver essetial advatage. For our maagemet magazie strategy+busiess, visit Visit to lear more about Booz & Compay. CONTACT INFORMATION Abu Dhabi Richard Shediac Vice Presidet richard.shediac@booz.com Rabih Abouchakra Pricipal rabih.abouchakra@booz.com Chadi N. Moujaes Pricipal chadi.moujaes@booz.com Beirut Maze Ramsay Najjar Associate maze.ajjar@booz.com Origially published as: Ecoomic Diversificatio: The Road to Sustaiable Developmet, by Rabih Abouchakra, Chadi N. Moujaes, Maze Ramsay Najjar, ad Richard Shediac, Booz Alle Hamilto, 2008.

3 1 Ecoomic Diversificatio The Road to Sustaiable Developmet A strog, growig, sustaiable ecoomy is the goal of every atio i the world. A sustaiable ecoomy ehaces a atio s stadard of livig by creatig wealth ad jobs, ecouragig the developmet of ew kowledge ad techology, ad helpig to esure a stable political climate. Havig a diverse ecoomy that is, oe based o a wide rage of profitable sectors, ot just a few has log bee thought to play a key role i a sustaiable ecoomy. Recet research by Booz Alle Hamilto cofirms that is ideed the case. There is a lik betwee ecoomic diversity ad sustaiability, ad ecoomic diversificatio ca reduce a atio s ecoomic volatility ad icrease its real activity performace. Furthermore, there are metrics that policymakers ca use to measure these key ecoomic dimesios ad ways that they ca promote their atio s log-term ecoomic health ad stability. Studyig Sustaiable Developmet: Ca Diversificatio Drive Sustaiability? This study grew out of Booz Alle Hamilto s work helpig Middle Easter govermets, particularly those i the Gulf Cooperatio Coucil (GCC), formulate their ecoomic developmet strategies ad trasformatio agedas that is, their trasformatios from ecoomies based o a sigle commodity to robust, well-diversified oes. These coutries, rich i hydrocarbos ad with ecoomies heavily ivested i oil ad gas, face a particularly dautig challege i diversifyig; cosequetly, it was importat to determie just how critical ecoomic diversity was to their creatio of sustaiable ecoomies. To aswer that questio, we broadeed our focus beyod the Middle East regio ad scrutiized 19 differet coutries aroud the world with varyig levels of ecoomic maturity to assess their ecoomic diversificatio, volatility, ad health. 1 We studied the followig: GCC ecoomies, cosistig of Bahrai, Kuwait, Oma, Qatar, the Kigdom of Saudi Arabia (KSA), ad the Uited Arab Emirates (UAE) Group of Seve (G7) ecoomies, cosistig of Caada, Frace, Germay, Italy, Japa, the Uited Kigdom, ad the Uited States Trasformatio ecoomies, cosistig of Hog Kog, Irelad, New Zealad, Norway, Sigapore, ad South Korea (these ecoomies iitiated or completed trasformatio to a idustrialized atio sometime i the secod half of the 20th cetury). Our aalysis idetified a clear lik betwee ecoomic diversificatio ad sustaiable growth. It also showed how diversificatio ca reduce a atio s ecoomic volatility ad icrease its real activity performace. These fidigs provide a firm remider to policymakers worldwide that oe key to buildig a strog, sustaiable ecoomy is buildig a diversified ecoomy oe that is ot overly depedet o a sigle commodity ad that has a strog exteral as well as iteral focus. 1 Data for this study were obtaied from the UAE Miistry of Ecoomy, Cetral Bak of the UAE, Saudi Arabia Miistry of Ecoomy ad Plaig, Saudi Arabia Moetary Agecy (SAMA), Cetral Bak of Kuwait, Oma Miistry of Natioal Ecoomy, Cetral Bak of Bahrai, Qatar Plaig Coucil, Iteratioal Moetary Fud (IMF) World Ecoomic Outlook 2006, Orgaisatio for Ecoomic Co-operatio ad Developmet (OECD), World Developmet Idicators (WDI), Ecoomist Itelligece Uit (EIU), Iteratioal Labour Orgaizatio, Abu Dhabi ad Dubai statistical yearbooks, official statistics bureaus of the sampled ecoomies, ad Booz Alle Hamilto aalysis. Some coutries are excluded from oe or more exhibits due to the lack of available data.

4 2 Evaluatig Ecoomic Diversificatio Our iitial aalysis of ecoomic diversificatio across the GCC, G7, ad trasformatio ecoomies produced three key fidigs. Gross Domestic Product (GDP) Should Be Distributed Across Sectors. To begi, we assessed the ecoomic cocetratio ad diversificatio of the GCC, G7, ad trasformatio ecoomies i the study. We wated to fid out whether their GDPs were evely distributed across a wide variety of ecoomic sectors or whether they relied heavily o just oe or two sectors. We measured diversificatio by evaluatig the distributio of a atio s GDP across its various ecoomic sectors, such as agriculture or maufacturig, to determie a cocetratio ratio ad a diversificatio quotiet. The cocetratio ratio measures a atio s cocetratio i a give sector by takig the sum of squares of percet cotributio to GDP. The diversificatio quotiet is the iverse of the cocetratio ratio; it provides a metric that policymakers ca use to gauge their atio s ecoomic diversity. Essetially, the lower the cocetratio ratio ad the higher the diversificatio quotiet, the more diversified a atio s ecoomy. The results of our aalysis showed that the level of diversificatio varied widely across the three studied categories, with the GCC coutries havig the highest cocetratios i terms of sector cotributio to GDP ad thus the lowest diversificatio quotiets (see Exhibit 1). The level of cocetratio for the G7 coutries, for example, was 16 percet; for the GCC coutries, 26 percet. The diversificatio quotiet for the G7 coutries was 6.07; for the GCC coutries, These fidigs were ot ecessarily surprisig. Historically, the ecoomies of GCC coutries have bee domiated by the oil ad gas sector, ad although the Exhibit 1 Ecoomic Cocetratio ad Diversificatio i the GCC, G7, ad Trasformatio Ecoomies, 2005 G7 Ecoomies Trasformatio Ecoomies GCC Ecoomies Ecoomic Cocetratio (Percetage of Real 2005 GDP) 3 39% 1 18% 19% 20% 23% 15% 19% 19% 19% 14% 19% 23% 26% 28% 33% Caada Japa G7 U.K. U.S. Frace Italy Germay Norway South Korea Irelad Trasformatio Hog Kog Sigapore* Dubai Bahrai UAE Oma GCC KSA Kuwait Abu Dhabi Qatar Ecoomic Diversificatio (Diversificatio Quotiet) Abu Dhabi ad Dubai show the disparity of levels of diversificatio withi a sigle coutry Diversificatio by Category of Ecoomies Methodology The cocepts of ecoomic cocetratio ad diversificatio ca be captured with the computatio of the respective poit estimators of cocetratio ratio ad diversificatio quotiet for the sample of studied ecoomies. The cocetratio ratio measures how cocetrated the particular ecoomy is i ay give sector by takig the sum of squares of percet cotributio to GDP. Equal to the iverse of cocetratio ratio, the diversificatio quotiet provides a umerical perspective with which coutries ca baselie ad target future ecoomic developmet. The lower the cocetratio ratio ad the higher the diversificatio quotiet, the more diversified the ecoomy. Commets Results show that GCC coutries have the highest cocetratios i terms of sector cotributio to GDP ad thus exhibit the lowest diversificatio scores. Nevertheless, the high reliace of ecoomic activity i the GCC o the oil ad gas sector does ot preclude the regio from effective ecoomic diversificatio. Norway is a parago of a hydrocarbo-rich atio that has successfully diversified ito productive o-oil sectors. Note: The aggregate scores for the G7, trasformatio, ad GCC ecoomies were calculated based o the total GDP breakdow for those ecoomies, ot o the average or media score for the idividual costituets. *As a result of Sigapore s focused ecoomic developmet strategies, the ecoomy has become somewhat cocetrated i two sectors: trade ad maufacturig. Sources: UAE Miistry of Ecoomy; SAMA; Cetral Bak of Kuwait; Oma Miistry of Natioal Ecoomy; Cetral Bak of Bahrai; Qatar Plaig Coucil; IMF World Ecoomic Outlook 2006; OECD; Abu Dhabi ad Dubai statistical yearbooks; official statistics bureaus of sampled ecoomies; Booz Alle Hamilto

5 3 relative cotributios of the GCC coutries various ecoomic sectors to GDP have shifted oticeably over the years, the oil ad gas sector has cosistetly represeted the largest share i these atios GDPs (see Exhibit 2). Moreover, registered growth i ooil sectors, such as maufacturig ad hospitality, geerally has reflected ot orgaic growth i those idustries but, rather, spillover effects from icreased oil receipts ad subsequet record-high iflows of capital. Needless to say, such types of growth caot be cosidered iheretly sustaiable, because they deped heavily o the domiat sector s fortues i the marketplace a paradigm that most atios would wat to avoid. A key coclusio that ca be draw from this ogoig tred toward cocetratio is that the GCC coutries o-oil sectors have ot fully matured ad still have pervasive structural gaps, such as iefficiecies i labor, capital, ad kowledge ad techology. I additio, this tred suggests that reveues from oil ad gas are ot beig reivested effectively i GCC coutries. Istead, excess liquidity is beig used to fud atios iteral (i.e., local) ecoomies, rather tha exteral ecoomies that is, those sectors that cotribute sigificatly to a atio s et export of goods ad services. This is a difficult patter to break; Russia, for example, despite beig cosumptio-geared, recetly aouced that it would begi ivestig more of its oil ad gas reveues i ifrastructure projects such as power ad trasportatio, hopig to create a ifrastructure that ca better support growig busiesses across all of its territories beyod Moscow ad St. Petersburg ad that ca eable developmet of outboud idustries. Although some ivestmet i iteral ecoomies is ecessary, havig a ecoomy with a strog foudatio i export helps to isulate a coutry agaist the vagaries of its domestic ecoomy. I the case of hydrocarbo-rich coutries, it also isulates them from the volatility of oil ad gas prices ad that volatility s trickle-dow effect o the ecoomy. Exhibit 2 GDP Breakdow by Ecoomic Sector i the GCC, GCC GDP i Real 2000 US$ Billios 100% $163.2 $199.6 $289.1 $ % 3% 5% % of GDP 80% 60% 40% 20% 0% 28% 3 60% 4 8% 8% 10% 8% 8% 9% 5% 8% 5% 6% 5% 18% 3% 11% 4% 8% % 5% 4% 3% Decade-o-Decade Chage i Diversificatio Agriculture, Forestry & Fisheries Miig, Quarryig & Eergy Maufacturig Costructio, Electricity, Water & Gas Trade, Restaurats & Hotels Trasport & Commuicatio Bakig, Isurace, Fiace, Real Estate & Busiess Services Govermet Services Other Services 2 1 GCC figures are based o a costructed sample of GCC GDP series, subject to data availability. 2 Other Services iclude commuity, social, ad persoal services; activities of private households as employers; ad udifferetiated activities of private households, as well as extraterritorial orgaizatios ad bodies. Sources: UAE Miistry of Ecoomy; SAMA; Cetral Bak of Kuwait; Oma Miistry of Natioal Ecoomy; Cetral Bak of Bahrai; Qatar Plaig Coucil; Booz Alle Hamilto

6 4 Cocetratio Is Not Ievitable i Hydrocarbo-Rich Ecoomies. Historically, the bulk of the GCC regio s ecoomy has bee very susceptible to such chages i oil prices, especially so i the larger ecoomies of KSA, Kuwait, Qatar, ad the UAE. For example: Sice 1975, KSA s overall GDP growth has bee drive maily by growth i the oil ad gas sector ad that growth has varied dramatically over the years, from egative 22 percet i the early 1980s to 10 percet i 2005, largely as a result of oil price chages ad shocks. The growth i o-oil sectors has varied less oticeably but oetheless has fluctuated ad has bee iflueced by chages i oil prices. This suggests possible cotagio effects that is, the tedecy of failure i oe ecoomic or fiacial area to spill over ito other, urelated or tagetially related areas. Kuwait, Qatar, ad the UAE display sector distributio ad growth patters comparable to those of KSA over the same period. The UAE s GDP growth has bee drive maily by the oil ad gas sector; effective growth of that sector has varied from double-digit egative to double-digit positive growth rates; ad growth of o-oil sectors appears to have bee affected by chages i oil prices. However, the UAE has recetly experieced some relative improvemet i its o-oil sectors, largely as a result of Dubai s efforts toward ecoomic diversificatio, such as the developmet of the Jebel Ali port ad harbor, various free zoes (i.e., eterprise zoes) throughout the city, ad extesive real estate complexes caterig to the travel ad tourism idustry. I 2005, oly 5 percet of Dubai s GDP came from the oil ad gas sector a strog testamet to the results that ca come from a regio s stalwart effort to diversify its ecoomy. Cotrast this with the UAE s Abu Dhabi, which drew 59 percet of its 2005 GDP from oil ad gas, ad whose growth i o-oil sectors cotiues to lag. A commo explaatio for the pervasive lack of ecoomic diversity see i areas such as Abu Dhabi is that ecoomic cocetratio is ievitable i regios that are rich i a particular atural resource such as Bruei, whose ecoomy is etirely depedet o its reserves of petroleum ad atural gas; Zambia, whose ecoomy is etirely depedet o its reserves of copper; or Botswaa, whose ecoomy is tied tightly to the diamod-miig idustry. However, our fidigs idicate that beig hydrocarborich does ot predestie ecoomic cocetratio. Norway, for example, produces approximately 3 millio barrels of oil per day a amout cosistetly exceeded oly by KSA yet it has bee able to adequately distribute its GDP across a variety of productive ecoomic sectors, ad its reveues from oil ad gas make up oly approximately a quarter of its domestic output. Caada has doe much the same; despite its healthy trade i oil ad gas, it receives oly 4 percet of its GDP from that idustry. Exhibit 3 shows the breakdow of GDP by ecoomic sector for the GCC, trasformatio, ad G7 ecoomies, as well as for Caada ad Norway specifically, i The differece i diversity across categories is wide. Comparig the diversificatio of the GCC coutries with the diversificatio of Caada ad Norway, specifically, shows the differece that adoptig sustaied, robust policies focused o diversificatio ca make i a ecoomy. Norway, for istace, has ot oly created a social pesio or sovereig wealth fud from oil profits that is ivested abroad, both isulatig the coutry from the shock of oil-price chages ad removig excess liquidity from the ecoomy. It has also ivested labor ad capital ad explored kowledge ad techology i idustries such as maufacturig that were doig well but had some depedece o oil, so that they could diversify. The success of Norway ad Caada also highlights the fact that atios rich i ay sigle commodity must be particularly attetive to the issue of diversificatio to avoid a atural tedecy toward ecoomic cocetratio. Labor Distributio Should Support Growth. I additio to examiig the distributio of GDP i the sampled GCC, G7, ad trasformatio ecoomies, we also examied the distributio of labor categories. I G7 ad trasformatio ecoomies, employmet teds to be balaced across a variety of profitable sectors, skewig slightly toward service sectors such as trade, tourism, fiacial ad busiess services, ad real estate. Overall, employmet distributio across sectors geerally reflects ad shapes GDP distributio across sectors.

7 5 Exhibit 3 GDP Breakdow by Ecoomic Sector i the GCC, G7, Trasformatio, Caadia, ad Norwegia Ecoomies, 2005 GDP i Real 2005 US$ Billios % of GDP 1 100% 80% 60% 40% 20% 0% Least Diversified $600 $1,660 $39,019 $1,133 $296 1% 3% 6% 4% 20% 1 24% 3 46% 28% 9% 4 9% 9% 6% 5% 9% 1 10% 21% 19% 13% 14% 25% 8% GCC 2 Trasformatio G7 Caada Norway 15% 9% 24% 18% 6% 9% 1 1 Most Diversified 1% Agriculture, Forestry & Fisheries Miig, Quarryig & Eergy Maufacturig Costructio, Electricity, Water & Gas Trade, Restaurats & Hotels Trasport & Commuicatio Bakig, Isurace, Fiace, Real Estate & Busiess Services Govermet Services Other Services 1 May ot total 100% due to roudig. 2 Total GDP regroups cosolidated ecoomic output from all six GCC ecoomies. Sources: UAE Miistry of Ecoomy; SAMA; Cetral Bak of Kuwait; Oma Miistry of Natioal Ecoomy; Cetral Bak of Bahrai; Qatar Plaig Coucil; IMF; OECD; official statistics bureaus of sampled ecoomies; Booz Alle Hamilto I GCC coutries, however, employmet is distributed quite uevely. The oil ad gas sector, which produces 47 percet of GCC coutries GDP, provides work for oly 1 percet of the employed populatio. The vast majority of the workforce is employed i sectors that are relatively less ecoomically productive ad of secodary strategic importace i sustaiable developmet such as costructio ad utilities, govermet, ad other services. Govermet services aloe costitute aroud 20 percet of total GCC employmet. This meas a majority of workers are laborig i sectors that are supportig other ecoomic sectors, rather tha drivig growth themselves. Coutries with this type of labor distributio may suffer ecoomically. Evaluatig Ecoomic Sustaiability After assessig the overall diversificatio of GDP ad employmet across sectors i our surveyed coutries, we set about measurig the relatioship of ecoomic diversificatio to ecoomic sustaiability. To do this, we coducted a collectio of time-series ad cross-sectioal aalyses measurig productivity ad competitiveess ad the relatio of ecoomic volatility to cocetratio, employmet, ad ecoomic performace. Ultimately, we assessed diversificatio agaist sustaiability to demostrate a statistically sigificat relatioship betwee the two. Poor Ecoomic Diversity Is Liked to Low Productivity ad Competitiveess. Productivity is directly related to competitiveess: The more people ad/or capital it takes to do a job or create a product, the lower productivity is. The lower productivity is, the more a product costs, ad the less competitive that product ca be i the marketplace. Because the workforce i GCC coutries is so sparse i its largest ecoomic sector (oil ad gas) ad so heavily distributed i less ecoomically importat sectors (costructio ad govermet), labor ad capital productivities i ooil sectors lag far behid those i oil ad gas. For example, i 2005, the GDP labor productivity i GCC coutries was US$1.6 millio per employee for the oil ad gas sector but oly US$9,300 per employee for costructio. GDP-to-credit capital productivity was US$121 millio per uit of credit for the oil ad gas sector but oly US$1.2 millio for costructio.

8 6 These fidigs are importat because labor ad capital productivity are key measures of sustaiable ecoomic developmet. It appears that poor ecoomic diversificatio reliace o a sigle ecoomic sector teds to have a ufavorable effect o the productivity ad competitiveess of the other, laggig sectors. Ideed, labor ad capital productivities across all GCC ecoomic sectors fall cosistetly below bechmarks; specifically those of comparable hydrocarbo-rich ecoomies (see Exhibit 4). This uderperformace is to a large extet persistet across the differet GCC ecoomies ad productive sectors, with hardly ay exceptios. Moreover, eve for the oil ad gas sector, GCC output per employee remais iferior to that of Norway (approximately US$1.6 millio/employee for the GCC coutries, versus approximately US$2 millio/employee for Norway), suggestig pervasive, ecoomy-wide iefficiecies or the use of less-tha-ideal productio processes. Those gais i labor ad capital productivities that have bee achieved have mostly bee visible i the oil ad gas sectors ad abset or egative i others. Evidece from the UAE, for example, shows that gais i productivity have bee offset by losses, thus leadig to relative stagatio i terms of overall productivity ad competitiveess (see Exhibit 5). Low productivity levels traslate ito high costs to produce goods ad services. That i tur has a direct, egative effect o competitiveess, slowig ecoomic growth ad threateig a atio s log-term ad sustaiable ecoomic developmet. High Ecoomic Cocetratio Leads to Volatile Growth ad Fluctuatig Ecoomic Cycles. High ecoomic cocetratio makes a ecoomy vulerable to exteral evets, such as chages i the price of the domiat commodity. The vulerability of the GCC ecoomies to this factor is show i Exhibit 6, which reflects the high sesitivity of GCC real activity to oilprice shocks versus the relative stability of the G7 ad trasformatio ecoomies over the same period. The exhibit shows that, with time, ecoomies worldwide have somewhat adapted to better absorb oil-price shocks, as busiesses, govermets, ad idividuals have itegrated chagig oil prices ito their decisio makig, expectatios, cosumptio, savigs, ad ivestmet patters. Despite this worldwide tred, the health of GCC ecoomies has remaied more correlated to oil prices tha has the health of G7 ad trasformatio ecoomies ad the GCC ecoomies are thus more exposed to the effects of volatile chages i price. Betwee 1999 ad 2005, for example, the GDP of G7 coutries shifted up ad dow Exhibit 4 GDP Labor Productivity i Comparable Hydrocarbo-Rich Ecoomies, 2005 $2,000 $1,992 GDP Labor Productivity US$ Thousads Per Employee $1,500 $1,000 $300 $200 $100 $0 $128 $1,358 $1,237 Miig, Quarryig & Eergy $96 $88 $50 $35 Maufacturig Lower labor productivity i Caada ca be mostly attributed to the existece of other o-oil miig elemets. $167 $144 $113 $98 Fiacial & Real Estate Services $132 $126 $55 $60 $58 Trasportatio & Commuicatio $102 $61 $33 $39 $48 $28 $9 Govermet Services Trade, Restaurats & Hotels $98 $81 $73 $54 $21 $6 Costructio, Electricity, Water & Gas $16 $20 Agriculture, Forestry & Fisheries $125 $69 $50 $36 Total Norway Caada UAE KSA Sources: Abu Dhabi Statistical Yearbook; Abu Dhabi Cesus; UAE Miistry of Ecoomy; SAMA; Statistics Caada; Statistics Norway; Booz Alle Hamilto

9 7 Exhibit 5 UAE Productivity Aalysis by Ecoomic Sector (Based o Recet, Reliable Data) Real GDP Growth 250% 200% 150% 100% Miig, Quarryig & Eergy 36% UAE Labor Productivity Aalysis, (i %) Trasport & Commuicatio Maufacturig 1 13% Employmet Growth Icreasig Productivity 13% Decreasig Productivity Trade, Restaurats & Hotels Nomial GDP Growth ( ) 120% 100% 80% 60% 40% Miig, Quarryig & Eergy 36% UAE Capital Productivity Aalysis, (i %) Maufacturig Trasport & Commuicatio Icreasig Productivity Decreasig Productivity Electricity, Water & Gas Govermet Bakig, Isurace, Fiace, 9% Services Real Estate & Busiess Services 50% Agriculture, Agriculture, 20% Forestry & Costructio* Other Govermet Forestry & Other Costructio, Electricity, Fisheries Services Services Fisheries Services Water & Gas* 0% 0% 0% 50% 100% 150% 200% 250% -50% -25% 0% 25% 50% 75% 100% 725% Total GDP No-Oil GDP Bakig, Isurace, Fiace, Real Estate & Busiess Services Trade, Restaurats & Hotels 13% 1 13% Sector Credit Growth ( ) Note: Size of bubble equals relative share of 2005 GDP. *Costructio is split from electricity, water, ad gas for the purposes of the capital productivity aalysis due to dramatic differeces i their respective growth rates. Sources: Cetral Bak of the UAE; UAE Miistry of Ecoomy; WDI; Booz Alle Hamilto oly 2 percetage poits per aum at most, although oil prices fluctuated dramatically. I cotrast, the GDP of GCC coutries from 1977 to 2005 moved betwee recessioary periods whe growth was less tha 0 percet, to relatively ormal periods with growth of 2 to 3 percet, to periods of explosive expasio, with growth jumpig to 9 percet. Furthermore, exposure to oil-price shocks has resulted i oscillatig busiess cycles, as ecoomies expad ad cotract i respose to rises ad dips i the price of oil, ad likely spillover of volatility from oil ito ooil sectors. Exhibit 6 Oil Price Chage versus Real GDP Growth i the GCC, G7, ad Trasformatio Ecoomies, % Chage i Oil Prices* 150% 100% 50% 0% -50% -100% The overreliace of GCC ecoomies o oil output led them to witess a recessioary period durig the 1980s. Although GCC ecoomies have become relatively less sesitive ad exposed to oil shocks with time, their overall GDP growth remais highly correlated with chages i oil prices % 15% 10% 5% -0% -5% -10% -15% % Growth i Real GDP GCC GDP Growth Trasformatio GDP Growth G7 GDP Growth Oil Price Chage * * Average aual Bret Crude Oil spot price from 1977 util 2005 was tracked agaist discrete aual real GDP growth for the GCC, G7, ad trasformatio ecoomies. Sources: WDI; Booz Alle Hamilto

10 8 This sesitivity of GCC ecoomies to chages i oil prices is maifested i growth volatilities across ot just oil ad gas, but all the differet sectors that cotribute to the bulk of ecoomic output ad employmet. Evidece from KSA, for example, shows that volatility is widespread i the kigdom s ecoomy, suggestig both iadequate ecoomic diversificatio ad sigificat spillover of volatility from oil to o-oil sectors. Several factors have cotributed to this spillover, icludig govermet sesitivity to o-oil spedig whe oil prices are low; a depedece i the o-oil iteral ecoomy o oil output ad prices; ad limited o-oil exports. Those factors also suggest iadequate ad relatively ieffective ecoomic diversificatio. Exhibit 7 shows that the highest growth volatility i KSA has bee i the oil ad gas sector, which costitutes the bulk of the regio s ecoomic output. Similar growth volatility is to a large extet pervasive across the ecoomic sectors of the other GCC coutries, particularly Kuwait, Qatar, ad the UAE. Growth volatility i oil ad gas ad a umber of other ecoomic sectors has bee as high as 18 percet i KSA ad i excess of 20 percet i the UAE. Although some volatility is to be expected i all markets, a high level of volatility hiders sustaiable ecoomic growth, maily because periods of prosperity geerally do ot offset the egative structural effects of bad times. I other words, ecoomic shocks ted to have a loglastig egative effect. Volatility i Cocetrated Ecoomies May Spaw Structural Uemploymet Issues ad Egeder Systemic Risks. Sigificatly, the elevated volatility see i GCC coutries is highest i the ecoomic sectors that employ most of those atios populatios. For example, volatility is prevalet i sectors that employ 85 percet of KSA s workforce ad i sectors that employ 80 percet of the UAE s workforce, icludig govermet services; costructio, electricity, water, ad gas; ad trade, restaurats, ad hotels. Havig such high volatility i such a large portio of ecoomic sectors presets a particular problem. It causes frequet uemploymet (uemploymet i most GCC ecoomies has bee cosistetly at double-digit rates, ad this employmet challege is expected to worse as a substatial segmet of the populatio reaches workig age i the ear future ad overflows the job markets) ad ofte results i high structural uemploymet rates that is, i this cotext, uemploymet that occurs because the available laborers do ot have the skills or kowledge Exhibit 7 KSA Employees ad Growth Volatility by Ecoomic Sector Icreasig Employmet Employees by Ecoomic Sector, 2005 (% of Total Employed) 40% 35% 30% 25% 20% G7 Overall Volatility = 1.3% Trasformatio Overall Volatility = 2. GCC Overall Volatility = 5.1% KSA Overall Volatility = 5.3% 6% 5% Costructio, Electricity, Water & Gas Trade, Restaurats & Hotels High growth volatility is see across KSA s ecoomic sectors, amely those that costitute the bulk of the employed labor force ad GDP output. Govermet 15% Services Maufacturig 15% Other Agriculture, 3% 10% 9% Services Forestry & Fisheries Bakig, Isurace, Trasport & 3% Miig, 5% Fiace, Real Estate Commuicatio Quarryig & Busiess & Eergy 3% 20% Services 0% 0% 5% 10% 15% 20% 25% -5% Growth Volatility, * (% of Volatility Growth) Icreasig Volatility Note: Size of bubble equals relative share of 2005 GDP. *Historical aggregate ad sector volatilities are measured by the stadard deviatios of aggregate ad sector real activity growth rates, respectively, over the sampled period. Sources: SAMA; KSA Miistry of Ecoomy ad Plaig; WDI; Booz Alle Hamilto

11 9 eeded to match the available jobs. Displaced workers with particular kowledge ad skill sets (or lack thereof) caot easily be moved ito differet sectors of the ecoomy without a extesive expediture of time ad traiig. Regios of the Uited States, for example, have suffered from structural uemploymet issues as maufacturig moves offshore ad former maufacturig employees struggle to fid a ew place i the ecoomy. Volatility i o-oil sectors i the GCC regio has decreased over time, ragig from 5 to 9 percet. This is a sigificat improvemet, give that the umber i the UAE, for istace, used to rage betwee 10 ad 35 percet. However, this reductio could be the result of there beig fewer aggregate shocks rather tha the result of effective diversificatio. Despite these reductios, growth volatility i GCC ecoomies remais high whe compared with the volatility of aalogous ecoomies. Exteral Trade Helps Reduce Ecoomic Volatility. O a positive ote, it does seem that this pervasive volatility (ad its edurig spillover effects) ca be mitigated with the developmet ad diversificatio of high-value-added exports of goods ad services. I the G7, GCC, ad trasformatio ecoomies studied here, whe o-oil exports are mapped agaist real activity volatility, a iverse relatioship is revealed betwee exteral trade diversificatio ad ecoomic ucertaity (see Exhibit 8). I a utshell, the higher ad the more diversified a coutry s exports, the lower its volatility. The evidece i Exhibit 8 shows that oil-depedet ecoomies such as those of the GCC ad ay ecoomies based o a sigle commodity will become effectively diversified oly whe they successfully create a robust quatity ad variety of exports ad worldwide purchasers for them. Norway ad, to a certai extet, Caada provide examples of atios that have doe this successfully. For Norway, o-oil exports make up 27.4 percet of its GDP, but it has oly a 1.8 percet GDP growth volatility score. This evidece serves as a further remider that policymakers i hydrocarbo-rich atios must pay attetio to the issue of ecoomic diversity ad i particular, to the developmet of exteral trade. Otherwise, high but cocetrated ecoomic growth is likely to be outweighed by excessive volatility ad lead to low risk-adjusted performace. Exhibit 8 Exteral Trade Diversificatio ad Ecoomic Stability i the GCC, G7, ad Trasformatio Ecoomies No-Oil Exports 1, Average 2 (% of Nomial GDP) GDP Discrete Growth Volatility, (i %) Trasformatio Ecoomies G7 Ecoomies GCC Ecoomies 78.4% 56.3% 42.4% % % Germay 25.5% 22.4% 21.1% 18.3% % 7.3% % 5.1% 4.6% 4.3% 3.3% 2.5% Sigapore Irelad Trasformatio South Korea Norway Hog Kog Caada Italy G7 U.K. Frace Japa U.S. Bahrai Qatar KSA GCC Oma UAE Kuwait % % 1.8% 4.6% % % % 1.9% 4.8% % 5.1% 6.9% 9.4% 9.0% Exteral Trade Diversificatio by Category of Ecoomies 1 Export data are et of reexports ad iclude oly exports of o-oil goods ad thus are ot iclusive of export services. 2 Average data rages vary for the differet coutries depedig o data availability. Sources: UAE Miistry of Ecoomy; SAMA; Cetral Bak of Kuwait; Oma Miistry of Natioal Ecoomy; Cetral Bak of Bahrai; Qatar Plaig Coucil; EIU; Booz Alle Hamilto

12 10 This ufortuate pheomeo is show i Exhibit 9, which evaluates the Sharpe ratio of the studied G7, GCC, ad trasformatio ecoomies. The Sharpe ratio measures a ecoomy s risk-adjusted performace that is, the average ecoomic retur per uit of volatility by dividig the ecoomy s average GDP discrete growth premium by the historical growth premium volatility. Exhibit 9 shows that ulike G7 ad trasformatio ecoomies, GCC ecoomies have high growth premiums that are outweighed by excessive volatility, leadig to low risk-adjusted performace. O average, the trasformatio ecoomies icrease volatility by 1 percet with growth of 2.52 percet; i compariso, the GCC ecoomies icrease volatility by 1 percet with growth of just 0.69 percet. I other words, for the GCC ecoomies, ay icrease i growth iheretly icreases ecoomic risk rather tha ecoomic reward. Diversificatio Is a Critical Compoet of a Sustaiable Ecoomy So what is the solutio? How ca ecoomies that have historically relied o the export of a sigle commodity reduce volatility, improve risk-adjusted real activity performace, ad therefore achieve sustaiability? Is ecoomic diversificatio truly a key part of accomplishig this? To aswer these questios, we compared: GDP growth volatility agaist ecoomic cocetratio for the studied coutries GDP reward-to-volatility ratio (i.e., the Sharpe ratio) agaist the diversificatio quotiet for the studied coutries. The results of our aalysis are show i Exhibit 10. These aalyses idetify a clear lik betwee ecoomic diversificatio ad sustaiable developmet. The lefthad side of the exhibit shows that atios with a high cocetratio ratio such as may of the GCC coutries suffer from sigificatly higher growth volatility tha do G7 or trasformatio atios. The right-had side of the exhibit tells the same story, from the opposite perspective. It shows that atios with a high diversificatio quotiet such as Norway, South Korea, ad Irelad ejoy a high Sharpe ratio; that is, a high ecoomic retur per uit of volatility. Exhibit 9 Real GDP Growth, Historical Volatility, ad Risk-Adjusted Performace i the GCC, G7, ad Trasformatio Ecoomies, Average GDP Discrete Growth Premium (% Growth) Discrete Growth Volatility (% Volatility) Sharpe Ratio (Reward-to-Volatility Value) Trasformatio Ecoomies G7 Ecoomies GCC Ecoomies Trasformatio Sigapore South Korea Norway Irelad Hog Kog G7 Frace U.S. Caada Japa U.K. Germay Italy Qatar Oma Bahrai Kuwait GCC UAE KSA 5.5% 7.0% 6.9% 3.3% 5.3% % 2.3% 3.1% 2.9% % 2.0% 2.0% 6.8% 6.8% 4.1% 7.0% 3.5% 5.5% % 1.8% 3.1% 4.6% 1.3% % 2.0% 1.9% % 4.8% 5.1% 5.3% / = 9.0% 9.4% Risk-Adjusted Performace by Category of Ecoomies Note: The average aual GDP discrete growth premium measures the adjusted real growth above a certai threshold that is equal to the risk-free real GDP growth rate of zero, which, i reality, is assumed to be a rate that matches year-o-year iflatio. Sources: UAE Miistry of Ecoomy; SAMA; Cetral Bak of Kuwait; Oma Miistry of Natioal Ecoomy; Cetral Bak of Bahrai; Qatar Plaig Coucil; IMF World Ecoomic Outlook 2006; OECD; official statistics bureaus of sampled ecoomies; Booz Alle Hamilto

13 11 It is importat to ote that the regressio estimators i the aalysis are statistically sigificat. About 30 percet of the variatio i GDP growth volatility ad reward-to-volatility ratio is captured by the sigle idepedet variables of ecoomic cocetratio ad diversificatio, respectively. The remaiig 70 percet of the variatio ot explaied by the regressio ca potetially be captured by other factors, such as oil prices, iflatio, exchage rates, ivestor ad cosumer cofidece, asset price shocks, ad so forth. May of these factors, despite havig some bearig o the ecoomy, would be difficult for policymakers to directly ad actively ifluece or shape. Ecoomic diversificatio, i cotrast, is measurable, moitorable, ad ow kow to be a critical compoet of a sustaiable ecoomy. Policymakers who wat to develop sustaiable ecoomies have a target i place ad have their work cut out for them. Effectig Sustaiable Developmet: Summary of Key Fidigs ad Recommedatios for Policymakers This study has goe some way i empirically validatig the liks betwee ecoomic diversificatio ad sustaiable growth. Our mai fidigs are as follows: Levels of ecoomic cocetratio ad diversificatio are very differet i the G7, GCC, ad trasformatio ecoomies, with the GCC ecoomies appearig to be the most cocetrated ad iadequately diversified. Hydrocarbo-rich atios, such as those i the GCC, are ot ecessarily destied to suffer poor ecoomic diversificatio, as show by the parago ecoomies of Norway ad, to a certai extet, Caada ad by the progress beig made i the UAE s Dubai, which goig forward would still eed to further develop its exteral markets. Levels of employmet distributio across ecoomic sectors are also very differet i the G7, GCC, ad trasformatio ecoomies. Employmet distributio seems to be balaced i G7 ad trasformatio ecoomies, but skewed toward low-value-added sectors, such as costructio ad govermet, i the GCC ecoomies. High ecoomic cocetratio exposes ecoomies to exogeous evets such as chages i oil prices; this exposure creates ecoomic volatility, as verified by the high sesitivity of GCC real activity to oil-price shocks. Exhibit 10 Relatioship betwee Ecoomic Diversificatio ad Ecoomic Sustaiability GDP Growth Volatility, GDP Growth Volatility vs. Cocetratio i the GCC, G7, ad Trasformatio Ecoomies Icreasig Growth Volatility UAE y = *x ** R 2 = Oma Qatar 0.06 Bahrai GCC KSA Hog Kog 0.04 South Korea Sigapore Irelad U.S Caada Trasformatio Norway Italy Germay U.K. G7 Frace Icreasig Ecoomic Japa Cocetratio Cocetratio Ratio, 2005 Kuwait GDP Reward-to-Volatility Ratio, GDP Reward-to-Volatility Ratio vs. Quotiet i the GCC, G7, ad Trasformatio Ecoomies Icreasig Risk-Adjusted 3.0 y = *x ** Performace R 2 = Qatar Kuwait KSA Oma GCC Trasformatio Sigapore G7 Irelad Frace Norway U.S. South Korea Hog Kog Caada Germay Japa Italy U.K. Bahrai UAE Icreasig Ecoomic Diversificatio Diversificatio Quotiet, 2005 *Idicates a statistical sigificace at a 99% cofidece iterval. **Pael-data regressios usig the Geeral Method of Momets (GMM) showed visible improvemets to the overall adjusted goodess of fit. Additioally, diagostic checks ad a collectio of regressios ru with a extesive array of cotrol variables asserted that the foud relatioships are both statistically valid ad reliable. Sources: Official statistics bureaus of sampled ecoomies; Booz Alle Hamilto

14 12 Overall volatility ad its esuig spillover effects ca be mitigated with the effective developmet ad diversificatio of high-value-added exports. Volatility miimizatio ad risk-adjusted real activity performace improvemet ca be largely achieved with icreased ecoomic diversificatio. These fidigs have importat implicatios for policymakers iterested i esurig that their atio ejoys a strog ad sustaiable ecoomy. This evidece shows clearly that policymakers particularly those whose ecoomies have historically relied o a sigle export must focus o ecoomic diversificatio whe creatig developmet agedas, ad must rigorously measure ad moitor ecoomic diversity i evaluatig the success of their policies. Specifically, policymakers should pursue the followig courses: Actively seek to diversify their ecoomic base i terms of ecoomic output ad iput distributios. Depedig o the degree of itervetioism appropriate i each coutry, public ad private stakeholders should icetivize the ijectio of labor ad capital ito productive ecoomic sectors that ca sustai real growth i the log-term, as well as the developmet of ew kowledge ad techology. Specifically foster the growth of the exteral sector whe promotig diversificatio; that is, the export of a wide rage of high-value-added goods ad services to a wide rage of destiatios. Cotiuously ad cosistetly ehace the productivity ad competitiveess levels of the ecoomic base by drawig o resources ad makig strategic ivestmets i sectors, idustries, ad value chais where there is a competitive advatage ad where there is market opportuity ad growth potetial. This effort ca ivolve ehacig huma capital, by icreasig educatio levels ad importig skilled talet, as eeded; ehacig fiacial capital by developig ew fiacig schemes ad istrumets; optimizig the exploitatio ad use of atural resources; ad ehacig techology ad kowledge with the aim of etrechig iovatio. Iovatio, i tur, allows ecoomies to create almost ex ihilo ecoomic value by iovatig a lik i the value chai, a idustry, a cluster, or eve a whole sector. This said, it remais crucial to a ecoomy s success to carefully time the trasitio toward iovatio-based output geeratio. Although preparig the groud ad establishig the prerequisites ad uderpiigs of a iovatio ecoomy should be iitiated at early trasformatio stages, the effective geeratio of ecoomic output out of iovatio sectors should come as a atural phase i a ecoomy s trasformatio path. A premature reliace o iovatio sectors is likely to miimize chaces of success ad expose a ot-yet-immuized ecoomy to harmful ad disruptive competitio. Use the metrics of ecoomic cocetratio ad diversificatio, as well as ecoomic sustaiability ad ucertaity, as targets whe determiig policy ad aim to further uderstad the dyamics betwee them. Moitor ad devise clear participatory ad itegrated diversificatio strategies ad mechaisms by which ecoomic volatility ad spillover effects, systemic ucertaity, ad perturbed busiess cycle trasitios ca be sigificatly mitigated. Takig these steps will help policymakers create logterm, sustaiable growth i their ecoomies ad i so doig, help esure stability ad a high stadard of livig for their atios. Also cotributig to this article was Carla Khoury.

15 Richard Shediac is a vice presidet with Booz & Compay based i Abu Dhabi. He specializes i fiacial services ad public sector projects ad has led ad participated i various strategy, operatios improvemet, ad orgaizatio projects i the Middle East, Europe, ad Asia. He ca be reached at or richard.shediac@booz.com. Rabih Abouchakra is a pricipal with Booz & Compay based i Abu Dhabi. He focuses o public admiistratio moderizatio, public policy, large-scale trasformatio, ad orgaizatioal developmet ad chage maagemet. He ca be reached at or rabih.abouchakra@booz.com. Chadi N. Moujaes is a pricipal with Booz & compay based i Abu Dhabi. He focuses o public policy, socioecoomic developmet plas, public admiistratio moderizatio, large-scale trasformatio, ad performace maagemet. He ca be reached at or chadi.moujaes@booz.com. Maze Ramsay Najjar is a associate with Booz & Compay based i Beirut. He focuses o public policy, socioecoomic developmet plas, macroecoomic policy ad goverace frameworks, ad turaroud ad trasformatio projects. He ca be reached at or maze.ajjar@booz.com.

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