Economist
Jan 9, 2016

The desert kingdom is striving to dominate its region and modernise its economy at the same time

FOR years Saudi Arabia seemed inert, relying on its vast oil wealth and the might of its American patron to buy quiet at home and impose stasis on its neighbours. But oil prices have tumbled, America has stood back from leadership in the Middle East, the region is on fire and power has shifted to a new generation—notably King Salman’s 30-year-old favoured son, Muhammad bin Salman. A sandstorm of change is rousing the desert kingdom.

The visible result is the brutal treatment of dissent at home and assertiveness abroad that has just been on chilling display. On January 2nd Saudi Arabia executed 47 people. Most of them were terrorists linked to al-Qaeda but some, including a prominent Shia cleric, simply called for the fall of the ruling House of Saud. After Iranians set fire to the Saudi embassy in Tehran in protest, the kingdom cut diplomatic, trade and air links, a grave and foolish escalation in a febrile region.

Away from the headlines, however, a different assertiveness could prove equally consequential. Prince Muhammad has drawn up a blueprint designed to throw open Saudi Arabia’s closed economy and government—including, he says, the possible sale of shares in the national oil firm, Saudi Aramco.

Coupling geopolitical swagger with sweeping economic change is a gamble. The outcome will determine the survival of the House of Saud and shape the future of the Arab world.

What is Arabic for Thatcherism?

The plunge in the price of oil, from $110 a barrel in 2014 to less than $35 today, was partly because Saudi Arabia seems determined to protect its share of the oil market. Nevertheless, low prices are a time-bomb for a country dominated by oil and a government that relies on it for up to 90% of its revenues. The budget deficit swelled last year to a staggering 15% of GDP. Although the country has $650 billion of foreign reserves, they have already fallen by $100 billion.

When oil prices fell in the 1990s, the Saudis simply borrowed heavily. They were saved when China’s boom sent commodity prices soaring again in the 2000s. This time no one, including the Saudi rulers, expects a return to triple-digit oil prices. Instead, they acknowledge that the economy must change. Speaking to The Economist this week (see Briefing), Prince Muhammad laid out a blueprint for reform that amounts to a radical redesign of the Saudi state.

The first step is fiscal consolidation. The goal is to eliminate the budget deficit in the next five years, even if the oil price stays low. Though there is much flab to cut, that is still a perilous undertaking which means dismantling the system according to which petro-cash, not taxes, pay for free education and health care as well as highly subsidised electricity, water and housing. More than money is at stake: this largesse has disguised how far the economy is chronically unproductive and dependent on foreign labour. It has been too easy for Saudis to avoid working, or to snooze away in government offices.

The new leadership has made a start. Spending cuts in the last months of 2015 stopped the deficit from soaring to more than 20% of GDP. The 2016 budget includes steep rises in the prices of petrol, electricity and water (though they remain heavily subsidised). The prince pledges to move to market prices by the end of the five-year period. He is also committed to new taxes, including a value-added tax of 5%, sin taxes on sugary drinks and cigarettes, and levies on vacant land.

Recalibrating taxes and subsidies is only the first step. Roughly 70% of Saudis are under 30. At the same time, two-thirds of Saudi workers are employed by the government. With the workforce projected to double by 2030, the country will prosper only if the sleepy statist economy is turned on its head, diversifying from oil, boosting private business and introducing market-driven efficiencies.

The government plans to do this by getting the state out of all but its essential functions. From health and education to state-owned companies, the new Saudi leadership is looking for privatisation and the private provision of public services. It has plans for charter schools and an insurance-based, privately provided health-care system. It is looking at the complete or partial privatisation of more than two dozen agencies and state-owned companies, including the national airline, telecoms firm and power generator. The biggest fish of all is Aramco, a national icon and almost certainly the world’s most valuable firm. The prince favours floating a minority stake in Aramco and opening its books to the world. He is urging his team to come up with a plan within months (see article).

Could such a blueprint become reality? Words are cheap and the obstacles huge. Saudi Arabia has promised reform before, only for its efforts to fizzle into insignificance. Its capital markets are thin and the capacity of its bureaucracy thinner. The investment that it needs in its young people, its non-oil industries, its tourism infrastructure and much else will not come cheap. It will not happen unless investors believe in the country’s future. That confidence will be hard to build.

The best-laid plans

One reason is that austerity on an almost Greek scale will be difficult and unpopular (though the examples of Syria and Libya are a deterrent against outright rebellion—see page 41). The state has provided generously partly to make up for the lack of political rights. Yet the royal family is reluctant to open the pressure valves that might make cuts more palatable. For all its economic urgency, the new regime shows no interest in political reform. Recent elections in which women were allowed to vote and to stand for (largely powerless) municipal councils were the idea of the late king. Nor is there a sign that the religious absolutism Saudi Arabia shares with its enemy, Islamic State, will soften. Even before the latest round, executions were at a 20-year high. Prince Muhammad waxes lyrical about the new generation. But he has little appetite to take on the conservative clergy over, say, the ban on women driving.

The other obstacle is geopolitics. As Iran has become more assertive, the Saudis have stepped in as the champion of Sunni Muslims. They have confronted Iranian-supported allies such as the Houthis in Yemen and Bashar al-Assad in Syria, as well as Shia malcontents at home and in neighbouring Sunni-ruled countries like Bahrain.

The new leadership argues that stability requires it to send a signal to terrorists (hence the executions). It feels obliged to defend its interests by resisting Iran which, it says, is bent on recreating a Persian empire. The argument is flawed: Saudi Arabia instead risks leading one side in a Muslim sectarian struggle it can neither win nor afford. The war in Yemen is a morass; support for Egypt and other Sunni allies is a drain. Defence and security already take over 25% of government spending and will eat up a growing share of a shrinking budget. Regional tensions will also deter private investment. Who would put trillions into an isolated economy in a region in turmoil?

The new regime seems to regard boldness at home and abroad as signs of a strong Saudi Arabia. Yet, though a muscular foreign policy plays well among Saudis, the economy will not thrive if the royal family ends up inflaming its region and blocking social reform at home. If Prince Muhammad is to remake his country, not wreck it, he needs to understand that.