The Economy

Saudi Arabia Table of Contents

THE DEVELOPMENT OF THE SAUDI ARABIAN ECONOMY has gone hand in hand with the establishment and expansion of the Saudi state during the last fifty years. The process of building the state, fortified by oil revenues distributed through the modern institutions of bureaucracy, worked to unify this economically diverse country. So pervasive has been the influence of these relatively young institutions that few vestiges of the old economy survive unchanged.

Before the discovery of oil in the Arabian Peninsula, it would be difficult to speak of a unified entity such as the Saudi Arabian economy. Before the 1930s, the region that would later come under the control of the Saudi state was composed of several regions that lived off specific resources and differentiated human activities. The western province, the Hijaz, for example, depended chiefly on subsistence agriculture, some long-distance trade, and the provision of services to pilgrims traveling to the holy cities of Mecca and Medina. A plantation economy that grew dates and other cash crops dominated the Eastern Province (also known as Al Ahsa, Al Hasa, and Ash Sharqiyah). An extremely hostile environment determined geographical separation of peoples. Because permanent habitation could exist only where there was water--at natural springs and wells--the long distances between water sources isolated clusters of people and hampered travel. The difficulty of travel also discouraged penetration from the outside, as did the lack of readily exploitable natural resources.

The discovery of oil in the Eastern Province in 1938 came just six years after another major development: the establishment of the Kingdom of Saudi Arabia, which unified a number of diverse areas of the peninsula under one ruler. Moreover, the rebuilding of Europe after World War II and its need for cheap, reliable sources of oil greatly enhanced the position of the newly established Saudi Arabian oil industry. The combination of these three events formed the basis of the current structure of the Saudi economy.

The quantum jump in revenues that flowed into the treasury of Abd al Aziz Al ibn Abd as Rahman Saud (ruled 1932-53) fortified his position and allowed the king to exert greater political and economic control over the territories he had conquered. At the apex of the economy was the state with all the mechanisms needed to ensure the rule of the Saud family (Al Saud). The state became the widespread agent of economic change, replacing the traditional economy with one that depended primarily on the state's outlays.

The conjuncture of these events also thrust Saudi Arabia, by virtue of its location and its enormous oil assets, into the center of the West's strategic concerns. At first the issue was the reconstruction of Europe; later, however, the steady flow of oil from the kingdom would be regarded as essential for international economic stability. In this sense, Saudi oil production and investment policies have assumed paramount importance to the industrialized world and, more recently, the developing world. This importance of oil to the West, particularly to the United States, could not have been more clearly underscored than it was by the Iraqi invasion of Kuwait in August 1990 and may have been a key reason for the massive military effort marshaled to expel Iraq from Kuwait. After the Persian Gulf War (1991), Saudi Arabia's standing in the world oil market increased, because it was the only major oil-producing country that had significant excess capacity of crude oil production and thereby a strong influence on international oil supplies and prices.

Maintaining this position in the international oil market has been the basis of Saudi economic policy in the early 1990s and was likely to remain so in the near future. Despite attempts to diversify the economy, developing a self-perpetuating nonoil sector has proved more difficult than earlier Saudi planners had envisioned. This is not to say that the government has not raised the average Saudi citizen's standard of living to one of the highest levels in the world and established for most of its inhabitants world-class infrastructural and social services. But sustaining real income growth still depended primarily on government spending, which was largely facilitated by oil revenues. Therefore, the government could not afford to neglect the oil sector, the primary engine of economic growth.

Developing the oil sector was crucial to domestic political stability, and it was the kingdom's importance as an oil producer that guaranteed its protection during the gulf crisis. During the early 1990s, it was becoming clear that with the expected decline of oil production from the republics of the former Soviet Union, combined with the stagnating output in other debt-ridden and geologically constrained Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC oil producers, Saudi Arabia had the chance to obtain a disproportionate share of any net increment of crude oil demand over the coming years.

Saudi Arabia had set out to meet this challenge with a major capacity expansion plan for its oil industry. First, the Saudi Arabian Oil Company (Saudi Aramco, the national oil company) accelerated plans to push sustainable domestic crude oil production capacity by 1995 to between 10.5 million and 11 million barrels per day (bpd) from 8.4 million bpd in 1992, with an increased share of lighter grades of crude oil produced. Second, the Saudi Arabian Marketing and Refining Company (Samarec) planned to upgrade its refineries to meet the new environmental standards in the West and growing domestic demand. Third, following its acquisition of downstream assets in the United States and the Republic of Korea (South Korea), the kingdom planned to purchase refining capacity closer to key consuming markets. Although shrouded in secrecy that made details observer, this strategy seemed designed to obtain or increase Saudi Arabia's market share.

During the 1970s and early 1980s, the sharp increase in oil prices relieved the chronic financial constraints that had plagued the Saudi state since its inception. Massive oil revenues, combined with delays in using the funds and the Saudi economy's limited absorptive capacity, created large financial surpluses in both the private and government sectors of the economy. The vast majority of these assets were invested in international financial institutions and in Western government securities.

After 1982 government authorities were obliged to change their emphasis from managing surpluses to coping with growing budgetary and balance-of-payments shortfalls. With the downturn in oil prices beginning in 1982, oil revenues to the kingdom began to recede. Given the huge investment expenditures to which it was already committed, the government was forced to finance large budget and current account deficits of the external balance of payments through foreign asset drawdowns. At first, the small decline in oil prices was considered a necessary "cooling off" period and a chance to review the investment program begun fifteen years earlier. Facing an ever-worsening international oil supply glut, the burden of reducing oil output under OPEC's newly installed quota system fell largely on Saudi Arabia. The kingdom's oil revenues therefore took a double blow--reduced prices and reduced exports--not to mention the devaluation of the United States dollar, the currency in which oil is sold on international markets. By late 1985, responding to domestic concerns, Saudi Arabia sharply boosted oil output in an attempt to regain its market share and to impose production discipline on other OPEC members. This policy led directly to the oil price crash of 1986.

The replacement in 1986 of well-known Minister of Petroleum and Mineral Resources Ahmad Zaki Yamani by Hisham Muhi ad Din Nazir, and King Fahd ibn Abd al Aziz Al Saud's personal intervention in the kingdom's oil affairs, were followed by a more commercial approach to oil exports that was designed to maintain Saudi Arabia's world market share. Greater OPEC discipline and a revival in world demand, stimulated by lower oil prices and rapid economic growth in Asia, helped return some buoyancy to the oil markets after 1986. Nonetheless, oil revenues in the late 1980s remained at 25 percent to 30 percent of levels during the early 1980s and proved insufficient to cover government expenditures and offset imports, thus perpetuating budget and external payment deficits. The authorities further reduced foreign assets and attempted to stanch capital flight (aggravated by the short-lived Iranian military thrusts into Iraq in 1986 and 1987 and the "tanker was" of 1987) and to induce the repatriation of private capital through the sale of government bonds. This strategy stemmed the hemorrhage. By early 1990, following the end of the Iran-Iraq War two years earlier, increased oil output and higher oil prices combined with improving private sector confidence to revive an economy that had contracted for several years in a row.

In the two months following the Iraqi invasion of Kuwait in 1990, all government efforts at restoring confidence in the economy since the 1986 price crash evaporated, precipitating another large outflow of private capital and a virtual standstill in domestic investment. But as oil prices and Saudi output soared to replace embargoed Iraqi and Kuwaiti oil, and with the arrival of the United Nation (UN) coalition forces, calm returned to the economy, helped no doubt by substantial expenditures related to the war effort. After the war, the repatriation of private funds and renewed economic confidence created what some journalists called a "miniboom." Despite budgetary problems at home and international economic problems, promising regional trade prospects emerged. Such prospects consisted of new markets in Iran, Central Asia, and South Asia, as well as the reconstruction of Kuwait, that opened new opportunities for Saudi businessmen.

The Persian Gulf War was disastrous for government finances, however. Higher oil revenues were insufficient to cover the estimated US$60 billion that the war cost the Saudi government. The authorities had to deplete the last of the financial reserves remaining from the oil-boom days of the early 1980s. In mid-1992, official external assets stood at the minimum needed for ensuring confidence in the Saudi currency, the riyal, and for maintaining prudent reserves. Although budgetary and external deficits have been sharply reduced, the government was forced to borrow on the international market and to reduce subventions to government enterprises, such as Saudi Basic Industries Corporation (Sabic) and Saudi Aramco, forcing such firms to seek capital overseas.

The status of government accounts in the aftermath of the Persian Gulf War clouded the prospects for smooth financing of the three major expenditure categories on the ruling family's priority list for the 1990s: the oil-sector capacity-expansion plan, major increases in defense and arms purchases, and the maintenance of public investments to sustain the domestic standard of living. The options faced by the government to alleviate its financial constraints were limited, especially on the oil revenue front, and debt financing would be clearly unsustainable over the medium term. During the 1990s, therefore, the government will probably strive for financial maneuverability by reducing the dependence of the private sector on government funds and by attempting to diversify budget revenue sources.

Factors that Transformed the Economy
Economic Policy Making
Five-Year Plans
Changing Structure of the Economy

For more recent information about the economy, see Facts about Saudi Arabia.

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Source: U.S. Library of Congress