HSBC argues for greater economic diversification

The first of a new economic bulletin from HSBC outlines the case for Middle East oil producing countries to maintain their commitment to economic diversification despite the return of higher oil prices.

HSBC uses the example of the UAE of an oil producing country that has successfully diversified its economy away from reliance on oil revenue. The UAE derived 72% of its GDP from non-oil sources in 2001 compared with just 56% in Kuwait.

Dubai's efforts at diversification are particularly commended. However, HSBC notes that this is partly down to the direct role played by Dubai Government which owns and operates Dubai Aluminium, Emirates Airline, the free zones, many hotels. The Government also holds a big stake in Emaar Properties as well as 100% of Palm Island developer Nakheel and other major real estate projects.

However, Dubai's free zones are host to more than 3,000 private companies, and are expanding further with the upcoming Dubai International Financial Centre and Dubai Metals and Commodities Centre.

The bulletin notes that other regional governments are now also adopting a proactive stance to foreign direct investment. The Saudi Arabian General Investment Authority and Bahrain Economic Board are two examples of such proactive inward investment agencies.

Nonetheless, HSBC can be criticized for emphasizing the positive while skating over some very palpable failures. For instance, the failure of the $25 billion Saudi Gas Initiative this summer casts a very long shadow over economic diversification and this in an industry where Saudi Arabia has a natural comparative advantage.

Will Kuwait do any better now with its proposed $7 billion foreign investment plan for the Northern oil fields? The new Cabinet has promised progress, but then it first made this promise in 1991 after the First Gulf War and not much has happened since.

Probably the main driver of economic reform in a place like Dubai is that its oil is running out, and the Crown Prince Sheikh Mohammed has a clear vision to meet this challenge. Elsewhere, leadership is lacking and without the political will nothing gets done.

Maybe it is, therefore, the general rather than the particular Dubai model of economic expansion that countries should choose to follow.

Dubai does not have the same local population pressures as some of its neighbours. Largely it has to be said, due to successful economic diversification over a long period which leaves local citizens a small minority in their own city.

There can also only be one regional trading hub and for other countries to try to out-perform Dubai is probably a futile exercise as Dubai has secured its position over many years, and is pushing out the boundaries further with more and more free zones. And indeed, of Dubai's 1 million inhabitants up to 90% may be expatriates and that is not a model any other country in the Middle East can or should follow.

Indeed, the place to look at in the UAE is Abu Dhabi. Most of the efforts and energies in Abu Dhabi go towards building up the energy sector and downstream activities such as petrochemicals and fertilizers. The UAE also has no problem with involving foreign companies in all aspects of the energy business and holds competitive tenders for most contracts.

So whether economic diversification is the right route can be questioned. Certainly the idea of every oil producer trying to become Dubai is unrealistic. However, greater foreign involvement to develop core energy assets must make financial sense and so does greater downstream diversification of these activities. There also needs to be stronger leadership to make things happen.

But to present Dubai as a shining example of how the Middle East can be reformed is a mistake. Dubai is an international city, populated largely by non-Arabs, and the rest of the Middle East will never be the same, nor should it attempt to be.