Not the Gulf Confrontational Council

If Gulf Cooperation Council moves towards greater intraregional economic integration were to be assessed the way a high school pupil's performance is, then the verdict would be something like: 'Making slow progress - more effort needed.'

But, to give credit where it is due, some positive steps have been taken in recent times. In February, for example, Muhammad al-Zarah, chief executive of the GCC Interconnection Authority, announced that tendering for the first phase of a $1.2 billion project to establish a power grid linking the states of the union would start later this year, with initial contracts awarded in 2005.

The first phase of the project will link Kuwait, Saudi Arabia, Bahrain and Qatar. Phase two will integrate the power systems of the UAE and Oman, using the UAE's grid to link the GCC North System through Tarif, and the UAE to Oman through Al-Ain.

A little earlier, at the GCC summit in Kuwait last December, the heads of state approved a unified law, with effect from the beginning of 2004, to combat dumping and provide measures for compensation and protection. GCC transport ministers were asked to prepare an economic study on the possibility of building a railway network to link the six member states. The summit also reviewed progress towards the establishment of a joint GCC market by 2007 and the introduction of monetary union and a unified currency by 2010.

At a summit two years earlier, the GCC had agreed to unify regional customs tariffs at five percent - compared to the existing four to 15 percent and broadly in line with World Trade Organization (WTO) requirements - as of January 1, 2003.

The customs arrangement provides for 'the procedural steps to be taken as regards the establishment of GCC Customs Union,' moving forward its enforcement date and lowering customs tariffs on all imported, non-customs union foreign commodities to five percent unless exempted in accordance with the Council's decision taken at the 20th summit conference.

It should be pointed out that there is already free intraregional trade for goods with 40 percent of their value added from GCC sources. The agreement also allows for the waiving of all fees on industrial machinery and raw material destined for industrial establishments in GCC member states.

With regards to the introduction of a single currency, the Committee of Monetary and Economic Cooperation and the Committee of Governors have been told to coordinate 'within a period not to exceed 2005, the necessary economic performance standards essential to the success of the Monetary Union.'

The GCC has also pledged to formalize standards and procedures such as agricultural quarantine systems and veterinary services, and decided to set up a new independent authority on standards and measurements.

A common market is expected to facilitate the conclusion of a trade agreement with the European Union (EU), which has thus far been impeded by the EU's tariff conditionality and, some argue, its protectionist stance in certain sectors. The GCC envoy to the EU, Najib al-Rawwas, said that 'now there are no more excuses for them to postpone signing the free-trade zone [agreement] between the two blocs.'

The GCC has been discussing the possibility of a unified trade and finance regime since it first signed an initial economic agreement (and was established) in 1981.

In 2001, the Bahraini finance minister, Abdullah Saif, reiterated the rationale behind the project, noting that a single currency 'will provide significant benefits for regional trade and investment. It will eliminate the costs and inconvenience associated with intra-Gulf foreign exchange transactions.

'By making the price of goods, services and investments readily comparable, this will enhance competition and improve overall economic performance.' He also said that the adoption of the same currency and associated monetary policies would facilitate decision-making and help generate foreign direct and portfolio investment and a single Gulf financial market.

Such benefits are broadly accepted, and economists point out that a common customs rate also provides greater market certainty and allows businesses, both domestic and international, to plan and target the regional market rather than just the domestic one, thereby creating economies of scale and ultimately the re-specialization of resources. However, progress in this direction has been less than speedy, largely due to vested sovereign interests (tariffs accrue to treasuries) and large discrepancies in official levels.

The UAE, for example, had voiced concerns that if the rate was set at 5 to 7.5 percent it would have to increase rather than reduce its current broad customs tariff rate of around four percent and thereby compromise Dubai's commanding position as a regional transit trade point.

There were also structural discrepancies: Saudi Arabia, for example, in the last 25-30 years has focused on developing import substitution industries and a protective regime to support them, while the UAE has focused on re-export and has an interest in customs liberalization. It is still not clear whether Saudi special tariffs, such as those on cement and sugar, will be reduced in 2005.

But the urgent challenges facing the region in the coming decade - rapid population increase, unemployment and debt growth, coupled with the renewed focus on the region's oil shock vulnerability - seem to have forced the issue.

In a matter of a few years, GCC states have seen crude oil prices spiral down to $8 a barrel and then climb back up to over $30 a barrel. The International Monetary Fund (IMF) has renewed recommendations that the GCC introduce taxes (ranging from value added to corporate and income) and reduce subsidies to offset this vulnerability.

Saudi Arabia is one of the GCC states calling for 'action rather than words.' During the 2002 summit, Crown Prince Abdullah complained that the GCC had not achieved the objectives defined in 1981. 'We have not yet set up a unified military force that deters enemies and supports friends. We have not reached a common market, nor formulated a unified political position on political crises . . . objectivity and frankness require us to declare that all that has been achieved is too little and it reminds us of the bigger part that has yet to be accomplished. We are still moving at a slow pace which does not conform with the modern one.'

The crown prince called on the GCC to stop hiding behind the veil of an exaggerated concept of sovereignty, pointing to the EU experience.
Despite rousing calls for faster progress, in practical terms there are still huge hurdles to overcome.

Both common tariffs and a common currency require common institutions - the most obvious being a single central bank - that the GCC has been less than adept at establishing. The GCC has yet to establish executive bodies that can enforce region-wide policies, with its Directorate acting more in the role of secretary than director.

The region's capital markets still operate totally independently, despite some cross listing and constant pledges to consolidate. And labor market flexibility - a prerequisite for a functioning common market - has yet to be addressed significantly in any forum.

The GCC's efforts to achieve greater economic integration - including the adoption of a common currency - are being encouraged by the IMF. It says that one of the key benefits of a unified currency would be to eliminate transaction costs involved in bilateral exchanges between the regional currencies.

This would also reduce accounting and other in-house costs for firms that operate in different countries in the region. Since foreign exchange costs are essentially a form of tax on intraregional trade and investment, their removal will contribute to further the region's economic integration. In addition, since intraregional trade is mostly non-oil related, the removal of foreign exchange costs can also be expected to contribute to the development of the non-oil economy.

To gain the full benefit of a common currency, however, the union needs to be seen as one component of a broader integration effort, which would have to include the removal of domestic and cross-border distortions that inhibit intraregional trade and investment, agreements on policy frameworks to minimize the risk of imprudent financial policies and further political integration to firmly lock in each country's commitment with the union.

On the downside, currency unification will make each country surrender the possibility of unilaterally changing the value of the currency it uses. For instance, the currency in question may suffer a large shock that requires sizable adjustment of its exchange rate and may assess that without a change in the nominal rate the adjustment to such a shock would require lowering wages and prices through an unacceptably large recession.

With a common currency, no individual country would on its own be able to undertake such a decision. In extreme circumstances - such as a massive crisis in the banking sector or in public finances - individual monetary authorities can ponder financing their lender-of-last-resort activities by printing money.

While this may not be the most attractive alternative, if a country has its own currency it remains a feasible sovereign decision. Furthermore, under a currency union, countries that face no fundamental problems of their own may end up suffering negative monetary spillovers from the macroeconomic imbalances of others in the region.

Ultimately, economic integration will succeed only if there is the political will - which means setting aside intraregional disputes and rivalry. On this score, the GCC's performance is patchy.

On the credit side, in March 2001, Bahrain and Qatar accepted the ruling of the Inter-national Court of Justice at The Hague on a long-running border dispute that had soured relations between the two states for decades. So great has been the turnaround in relations since then that Bahrain and Qatar are cooperating on a project to build a causeway linking them and on a range of other joint schemes.

Having said that, an outstanding border issue between Qatar and Saudi Arabia - compounded by a diplomatic row over a program broadcast by Doha-based Al Jazeera television - is holding up a major regional cooperation project. Qatar has agreed in principle to supply Kuwait with natural gas from its giant offshore North Field.

For this to happen, however, the pipeline has to pass through Saudi waters. And the Saudi government has so far not responded to requests for transit rights because of its differences with Qatar. Furthermore, the planned Dolphin Project - to take Qatari gas to the UAE - still awaits the settlement of regional differences over a sales price.

Aside from the energy sector, the GCC states appear to be sliding backwards when it comes to civil aviation cooperation. Far from putting their energies into developing one or two strong and internationally competitive regional airlines, they are bent on starting up a handful of new ones.

These shortcomings - based on the desire of individual countries or emirates to vie with their neighbors on prestige projects - do not justify the remark of a Western diplomat in Saudi Arabia who recently described the GCC as the 'Gulf Confrontation Council.'

But they are indicative of the work that remains to be done to remove the traditional rivalry in the region. Which is why the report card continues to stress that more effort is needed.