Question

Q: UAE as an oil-based economy is ambitious to have, ”sectoral diversification”, how it can be achieved? Suggest as a managerial economics researcher.

Note: answers should be in Details and in your own Words - the answers should be typed in a word version

Answer 1

1. Introduction

Today the United Arab Emirates (UAE) is the second largest Arab economy and belongs to high

income countries, even if the road towards this goal was different than many other countries. In fact, the UAE

has not gone through the hypothetical “stages” that most developed countries seem to have experienced

.

Massive oil revenues have enabled the UAE to short-cut the usually difficult and lengthy process of saving

and capital accumulation necessary for economic development .

From 2000 until 2012, the UAE GDP growth rate averaged 4.7 per cent, a good performance

considering the severe global economic crisis of 2009. In particular, in 2012 the economy of the United Arab

Emirates has witnessed a growth of about 4 per cent despite the difficulties posed by the eurozone and the

global outlook negative. Although the relative contribution of the different economic sectors to GDP has

shifted considerably over the years, the oil and gas sector represents the largest share in the GDP of the United

Arab Emirates, since the country is endowed with vast resources of oil and gas. So the UAE’s economy has

still a relatively high concentration of GDP in the oil sector and in related industries, and diversification is not

fully satisfactory. Such type of economic model cannot be considered inherently sustainable in the long run,

because it depends heavily on the dominant sector’s fortunes in the marketplace.

Historically, the UAE, as many other economies of the GCC region, particularly the Kingdom of Saudi

Arabia (KSA), Kuwait, Qatar, was very sensitive to changes in the prices of oil. On the other hand, the non-

oil sectors have not fully matured and still have pervasive structural weaknesses, such as inefficiencies in labor,

capital, knowledge and technology.

Taking as its starting point the Vision 2021 of the Federal Government of the UAE, which aims to

transform the economy into a more skill-intensive and diversified knowledge economy, points depicted by me are:

the major features of the UAE’s economy, its factors of strengths, underlining also its critical aspects. In

addition, the key factors that characterize a diversified knowledge economy, indicates

the policies that the economy of the United Arab Emirates should pursue in order to improve its performance.

2. The profile of the UAE’s economy.

The world has been living the deepest economic crisis since generations. The economic crisis clearly

slowed down the process of world-wide globalization

, so the standstill in the globalization process is visible

in all world regions

.

In the post-global crisis, the United Arab Emirates is challenged by a weaker global demand, but also
by the competition from other countries and more stringent global financial markets. One of the main lessons
of the recent global economic crisis for the emerging market economies, like the United Arab Emirates, is that
sustained economic growth in the future would require developing a better capacity to respond to future crises
through more robust regulatory systems and a more diversified economy. However, the UAE in the last decade
experienced some relative improvement in its non-oil sectors, achieving the goal of being the second largest
Arab economy and, very recently, the country has been ranked as the 7th strongest Asian economy.
The UAE became an independent state in 1971, with the establishment of its formal economic, social,
and political institutions. The country is a federation made up of seven Emirates: Abu Dhabi, Ajman, Al
Fujairah, Dubai, Ras al Khaimah, Sharjah, and Umm al Qaiwain.
This complex process of nation building was among the causes for implementing a development policy
on a interventionist-redistributive model, favored by the huge oil revenues . This development
policy, thanks to the oil revenues that accrued in the country since the 1970s, permitted the creation of a vast
welfare system for the population of the Emirates. Thus, UEA has enjoyed a political and social stability thanks
to the distribution of its huge oil revenues in the form of social and economic infrastructure, high standards of
social services (health, education) . In the UAE, like other oil exporting countries of the Gulf
region, the motivation for the statism of the interventionist policies was to support the emergent private sectors.
This State’s strategy has stimulated massive investment by some large industrial complexes for developing the
productive base of the economy and to diversify the sources of income. The industrial sector has made
remarkable achievements especially in terms of the increase in the number of enterprises. Industrial activities
have been facilitated by competitive low labor and energy costs, favourable tax laws and political stability
.
The hydrocarbon industry is one of the most important economic sectors of the economy, and since
this industry is high capital intensive, the number of workers that it employs is a small fraction of the labor
force. In fact, it is well known that natural resources in general, and in the specific case oil wealth per se,
creates few jobs directly. So this is why the non-oil private sector has to address the challenge of
unemployment. The UAE has also created viable small and medium enterprises in manufacturing and
services
. At the same time, despite efforts since the 1980s to limit hiring and downsize the public sector, state
bureaucracy in the UAE maintained its dominant position in the labor market
. Regarding such destination of
human capital in public sector employment, in the long run the most
detrimental impact of the large role of government hiring is that it traps human capital in unproductive public
sector jobs, thus limiting its contribution to economic growth.
The UAE’s economy, like others oil exporting countries, faced considerable oil price volatility in the
1990s
. However, in that decade, the UAE registered a real GDP growth averaged about 7 percent. Much of
this growth was created through diversification in non-oil sectors: first, in energy-intensive, petrochemicals,
fertilizers, cement and aluminum, and subsequently, tourism, trade and manufacturing . So
the UAE has been following a largely successful diversification strategy away from oil dependency and
has been equally committed to its outward-orientated growth policy. The previous vision of UAE, aimed to
define the UAE’s economy as a regional financial pivot and international trading hub, has gradually realized.
High capital productivity has filtered into high levels of gross domestic product (GDP) and the country enjoyed
remarkable growth rates also in the period 2000-2005
. Yet, labor productivity remained relatively low in the
country and total factor productivity gave a negligible contribution to economic growth
. Due to the lack of
national high-technology sectors, UAE aimed to acquire and access foreign technology, in particular
technology from the highly industrialized OECD countries, instead of generating its technology.
The labor force in the UAE is made up of more than 2.5 million employees of whom 86.5 per cent are
male and 13.5 per cent are women. The labor market in UAE is based on sponsorship system or Kafala system.Each employee must have a sponsor or kafeel . In the private sector, each worker must have a local
sponsor who is expected to have a business for which it needs workers. Instead, for those working in the public
sector, the government department employing the worker is the kafeel. Thus, the sponsorship system is the
legal channel through which expatriates obtain legal entry as guest workers in the UAE. In addition, the
Emiratization process establishes a set of rules that protect the national citizens of the UAE from open
competition from expatriate workers. The process sets minimum quotas of national workers for firms with 100
or more employees, enables the nationalization of particular work positions, and makes it almost impossible
to fire national workers once they are employed. Emiratization is undoubtedly important for social and political
and also economic reasons. The process aims at bridging the gap between the human capital needs of the
private sector and the need to employ national workers. But, at the same time, it has the potential to distort
incentives in the labor market, because it forces firms to hire according to a quota system, while not necessarily
motivate national employees to acquire those skills required to become competitive in the private sector
economy (Dubai Economic Council 2011). Definitely, together with the effects on migrants as a result of the
sponsorship system, the Emiratization process adds to the labor market distortions that lower the productivity
of firms and their degree of competitiveness.

During the years preceding the global economic crisis the UAE’s economy was performing fairly well.
The United Arab Emirates GDP Growth Rate reached an all-time high of 9.8 percent in 2006, while in the next
two years (2007 and 2008) the pace of growth has diminished to 3.2 percent at constant prices. The Non-Oil
sector recorded the highest rate of growth of 9.3 percent in 2007 and a good 6.0 percent in 2008
.
Conversely, the global crisis has severely hit the UAE’s economy, so the GDP contracted of 4.8 percent
at constant prices in 2009, led by a remarkable fall in manufacturing, but also in real estate. The year of the
crisis, i.e. 2009, hit more heavily the economy on the whole than the Non-Oil sector, which experienced a
decrease of 2.9 percent. But the manufacturing industries have particularly suffered with a decrease of 14.1
percent. However, the economy regained confidence after the crisis.
In 2010 the growth of GDP was a respectable 1.3 percent at constant prices. Furthermore, as is
documented in the Annual Economic Report 2012 of the UAE Ministry of Economy, during 2011 the GDP
has grown in the UAE at a rate of 4.2 percent at constant prices, despite the political events in some Arab
countries, the lower rate of growth of the global economy from 5.2 percent in 2010 to 3.8 percent to 2011, and
the financial crisis at the Eurozone that determined a decline in the GDP rate of growth in the advanced
economies to 1.6 percent. In addition, the public finance are in a good health. In 2011 the public debt was 16.9
percent of GDP, whereas the Government’s fiscal budget was in surplus of 11.2 percent of GDP, but during
2012 it is improved further to 12 percent of GDP, due both to the counter cyclical policy implemented by the
Government to avoid potential spillovers from conflict-stricken countries and to the boom of oil markets
experienced in 2011.
Finally, the recovery of oil prices following the global financial crisis has been helping to maintain the
commercial viability. Thus, the UAE’s economy has proved to be remarkably resilient to the difficulties thathave characterized the world economy. After the 2009 crisis the UAE’s Government has implemented some
political reform and more investment in the less wealthy Emirates.

The UAE's economy is continuing to rely on the hydrocarbons sector to drive growth, but the non-oil
sector is going to become increasingly important, especially in the near future when several major industrial
projects will come on stream. In fact, the large projects include the petrochemicals city, Al Gharbia Chemicals
Industrial City (Chemaweyaat), which is due for completion in 2015 (a business of USD20bln), but also the
considerable expansion of Emirates Aluminium (EMAL) by the end of 2014.
In the post 2009 recovery, the major drivers of the non-oil sectors have become trade, tourism,
logistics and manufacturing. However, the road of UAE towards a diversified knowledge economy is not
completed yet, so the next section examines the characteristics of a knowledge economy and the ways of
achieving a knowledge economy diversified and well developed.

3. Towards a diversified knowledge economy.

Diversification is important to promote economic development, to create job opportunities for a rapidly
growing local workforce, but also to reduce or spread the risk of a high economic concentration, which makes
an economy vulnerable to external events, such as changes in the price of the dominant commodity. An
increased economic diversification can improve the performance of the economy, minimize volatility and
facilitate the path of sustainable development. More specifically, overall volatility and its ensuing spillover
effects can be mitigated with the effective development and diversification of high-value-added production,
but also by an increase in exports of goods and services of high quality.
It is well known that modern growth economics has focused on technological innovations and high-
technology research and development as the engine factors for economic growth. In particular, endogenous
growth theory has highlighted the importance of technological progress and factor productivity . Other lines of research also emphasized the role of institutions as a fundamental cause of long-run
growth . Recent development experiences suggest that an appropriate
business environment is among the key ingredients of sustainable development.
The UAE 2021 vision, recently taken by the Federal Government, looks at innovation and knowledge
as the key drivers of the economy
. Government policies, incorporated into the UAE 2021 vision of the economy based on innovation and knowledge, constitute an important step towards a diversified knowledge
economy and a new growth model, but these policies should aim at creating an appropriate business
environment and also an integrated set of soft and hard institutions. UAE, in fact, does not ranks well in
protecting investors and on contract enforcement.

In 2015, 70 percent of the UAE’s GDP came from non-oil sectors, including media, telecom, tourism, manufacturing and commercial aviation. Underscoring the UAE’s emergence as a hub for business, the Global Entrepreneurship and Development Institute recently named the UAE the top country for entrepreneurs in the MENA region.

These diversification efforts are driving economic growth, with the UAE’s real GDP growing 3.5 percent in 2015.

diversification implies a structural change of the economy. Structural change usually refers to profound changes in the composition of employment and in the relative contribution of primary, secondary and tertiary sectors to aggregate growth . Consequently, structural change implies agriculture transformation, industrialization, urbanization, changes in the production structure and in domestic demand, foreign trade and finance. To have a more diversified economy it is necessary to invest in productive sectors which can sustain, with their high levels of productivity, real growth in the long-term, as well as the development of new knowledge and technology. But also, it would be appropriate to foster the growth of the external sector when it promotes diversification, ie, the export of a wide range of goods and services with high added value to a wide range of destinations.

Moreover, knowledge and skills have become the global currency of 21st century economies. With the globalization and with the related fully mobile capital, there is no reason for countries to limit themselves to patterns dictated by endowments, as conventionally defined; more important is the endowment of knowledge and entrepreneurship. A major focus of policy should be on how to enhance and shape such endowments. Therefore, it is rationale to move in the direction and to implement a new development model for the UAE, which involves a more diversified knowledge-based economy. As it is written in the UAE Vision 2021, the main target of an economy that aims to compete in the global markets is to become a more skill-intensive and diversified knowledge economy. The State, howeverhas an important and useful role to play in promoting industrial diversification, upgrading and implementing policies to assist firms in these processes. Knowledge economies, unlike economies that depend on finite natural resources, rely on the potentially unlimited creativity and talents of its people to generate economic value. Constructing a knowledge driven economy requires new skills, new ideas and a high level of creativity from a high-trained, flexible and adaptable workforce.

According to the World Bank the four pillars of a knowledge economy are: economic incentive and institutional regime; education and human resources; the innovation system; information and communication technology (ICT). But, ultimately, a knowledge-based economy is characterized by an ecosystem of interconnected elements and networks that allows a country to generate, adopt, adapt, diffuse and commercialize knowledge-intensive products and services.

All these changes have contributed to ensure that today UAE is a modern, wealthy and efficient economy that belongs to the high income countries, in fact, in 2011 its GDP per capita has been about $ 48,800.

However, despite the notable success of the United Arab Emirates in putting together a favorable business environment for growth and private sector development with minimal restrictions on private-sector activities, international trade and capital movements, there are areas where much more needs to be done. In particular, the overall investment regime remains restrictive. To continue the process of diversification and development government policy should aim at promoting innovation and market sophistication through appropriate regulatory systems. This can be done, for instance, by issuing strong consumer protection laws, issuing investment laws, solving the problem of the access to commercial land and other land-related issues, making a more efficient and easy access to finance. Other economic policies should keep to favor a stable macroeconomic environment, to promote the training of skilled labor force, to implement an efficient public sector and also to put a greater emphasis on creating an environment conducive to business, in particular to the small and medium enterprises (SMEs).

CONCLUSION

• The economy of the United Arab Emirates will continue to rely on the hydrocarbons sector to drive growth, but the non-oil sector is becoming increasingly important, thanks also to the major industrial projects that will come on stream in the next years and to its 2021 Vision, which aims to place innovation, research, science and technology at the middle of a knowledge-based, highly productive and competitive economy. UAE remains the top destination for foreign capital in the GCC region. Since 2009, global banks have actually increased lending to the United Arab Emirates, notwithstanding already high exposures. Moreover, the UAE in general, and Abu Dhabi in particular, have extensive sovereign wealth funds (SWFs), established to secure and maintain the future welfare of Emiratis, playing also a leading role in the development and governance of the industry.

Despite all of that UAE’s Government should improve the regulatory systems, as it has been argued in the previous sections. More should be done, especially regarding the overall investment regime that remains restrictive. The objective of macroeconomic stability, through effective monetary, fiscal and exchange rate control policies, is also essential to implement structural reforms and to facilitate the action of investors. Although, in the current economic scenario, it is possible that there could be problems of increasing financing costs due to the increased global risk aversion influenced by the geopolitical tensions in the neighboring countries and the financial problems in the euro-area.

The functioning of labor market must be improved, so to make possible to create more productive employment. Also, total factor productivity must be increased to foster growth. In addition, the gender gap must be passed within a period of time not too long and the young generations should find more opportunities for entrepreneurship and business activities.