ARGUMENT: Mohammed bin Salman Isn’t Wonky Enough

Saudi Arabia’s crown prince knows his country needs an economic overhaul, but his plans don’t add up.

By Steffen Hertog, FP

Saudi Arabia has moved from political paralysis to rapid action under the de facto leadership of Crown Prince Mohammed bin Salman. He has introduced a raft of ambitious economic reform plans, including the kingdom’s first multiyear fiscal adjustment program, plans for the partial IPO of the national oil company Saudi Aramco, a wide-ranging privatization scheme, and several programs for state investments in new industries. He has swiftly removed his rival Mohammed bin Nayef as crown prince and led a far-reaching anti-corruption purge, leaving old elites stunned — and with lighter wallets.

Like Western investors, the kingdom’s elites are uncertain about what the new order means for the country’s economy. The new Saudi leadership has indeed created new opportunities, but many of the deep structural barriers to diversification remain unchanged. The bulk of the public sector remains bloated by patronage employment, the private sector is still dominated by cheap foreign labor, and private economic activity remains deeply dependent on state spending. Addressing these challenges could take a generation — and it will require patience, creativity, and a clearer sense of priorities.

Saudi Arabia has seen a complete reconfiguration of its ruling elite in the past three years: While a band of Al Saud brothers used to rule collectively with the king as a figurehead, decision-making has now become centralized under one man. Through Cabinet reshuffles and a sudden corruption crackdown, Mohammed bin Salman shocked the ruling family and business elites with his ruthlessness and willingness to take risks radically at odds with the cautious and consensual political culture of the Al Saud clan. While the anti-corruption crackdown was by and large nonviolent, there is no precedent of such a comprehensive purge in any modern Arab monarchy.

The crown prince’s policies may help the country’s bottom line. The Saudi economy faces deep structural challenges, including a large fiscal deficit due to lower oil prices and a private sector desperate for diversification. Centralization of power is required to tackle them — even if measures like the corruption purge showed little outward concern with due process or transparency. Under the new leadership, Saudi Arabia has tackled fiscal reforms more vigorously than most local and international observers expected, introducing unprecedented tax and energy price measures, including the introduction of a 5 percent value added tax, new levies on foreign workers, and increases in electricity and transport fuel prices. The government is now experimenting with new non-oil sectors with an increased sense of urgency, including information technology and defense manufacturing.

Most impressively, the crown prince has begun liberalizing the kingdom’s restrictive social policies. The process started under King Abdullah but has now accelerated. While space for political opposition arguably has narrowed, women will soon be allowed to drive and the religious police force that once harassed them has been almost entirely neutered. By relaxing religious controls over the public sphere, the crown prince is seeking to attract more foreign investment and facilitate diversification into tourism and entertainment.

But the government hasn’t developed a strategy for other key economic issues yet. One powerful constraint is the country’s lack of administrative expertise: The government has only implemented a small fraction of the 543 initiatives in the 2016-2020 National Transformation Program, which was meant to be the cornerstone of economic reforms. Private businesses and technocrats often appear confused over the government’s priorities. New policies and programs are announced constantly, while the delivery capacity of the sluggish Saudi bureaucracy continues to lag. Below the upper echelons, the Saudi state remains the deeply fragmented, bloated, and slow-moving machine that I described in my 2010 book. The government seems to have no clear strategy for reforming this bureaucracy.

Moreover, almost all economic activity in the kingdom is deeply dependent on the state. For decades, the royal family has provided cheap energy to businesses and households as a tool of wealth-sharing, thereby creating inefficient and subsidy-dependent industries. Much to its credit, the government has committed to gradually phasing out subsidies, but the adjustment for the kingdom’s basic industries will be painful. Local economic advisors fear that the majority of private petrochemicals firms — the most developed part of Saudi industry — would lose money if prices of natural gas, their main input, increase to American levels.

More important, public sector employment remains the key means of providing income to Saudi nationals. Cheap foreign labor dominates private sector employment, thereby keeping consumer inflation at bay and business owners happy. Citizens, however, are parked in the overstaffed public sector. Out of every three jobs held by Saudis, roughly two are in government. The average ratio around the world is one in five. Public sector wages account for almost half of total government spending, among the highest shares in the world. Government recruitment has been largely frozen since 2015, but this imbalance will take decades to resolve, even if the government manages to create private jobs for Saudis at an unprecedented pace.

As limits on government employment kick in, young Saudis will increasingly have no choice but to seek private jobs. But they will face tough competition on the private labor market where employers have become accustomed to recruiting low-wage workers from poorer Arab and Asian countries. According to official survey data, average private wages for Saudis are about $2,700 per month, while foreigners earn an average of just $1,000. Reliance on unskilled foreign labor has in turn led to low output per worker and, given the workforce’s limited training, low use of advanced technology across most sectors. Most Saudi products are unsophisticated, yet the costs of production in the kingdom — a country with a fairly high standard of living — are higher than in other emerging economies that produce basic goods. This makes it hard for Saudi Arabia to compete on international markets. As a result, non-oil exports outside of the basic industries sector are very small.

Many Saudis in the private sector also have higher expectations regarding wages and work conditions than the low-cost foreigners who outcompete them. Saudi wage demands will have to drop further if private job creation is to substitute for the erstwhile government employment guarantee. For the time being, private job creation has stalled as the government has pursued moderate austerity since 2015 in response to deficits and falling oil prices.

The government has also underestimated how dependent private businesses are on state spending. The share of state spending in the non-oil economy is extremely high compared to other economies. Historically, almost all private sector growth has resulted from increases in public spending.

Through state employment, the government provides the lion’s share of Saudi household incomes, which citizens then spend in the local economy. While private sector wages to foreigners are almost as large as public wages to citizens, foreign workers remit most of that income abroad, so it does not bolster the local economy. Many firms also depend on state contracts; when the government delayed payments to them, it plunged the Saudi construction and contracting sector into depression in 2016, showing what can happen to an economy when the state is the dominant source of demand.