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Economics: Awash in Dough
New York: May 12, 2008
By John R. Stephenson

Times are pretty good, but for the elite in the Gulf region, they are positively giddy times. Awash in a sea of petrodollars, the glittering skyscrapers of Dubai and Abu Dhabi are ample testament to the region's new wealth. It wasn't all that long ago — back in the 1990s, when oil prices were weak and the governments of the Gulf were insecure and indebted. My how things change! Today, the challenge for the region is not one of debt repayment, but rather one of how best to invest their massive windfall from oil profits.

And invest they have. The Gulf is doing its best to spend its windfall, with stately pleasure domes springing up all along the coast. Dubai boasts the world's only seven-star hotel, the sail-shaped Burj al-Arab. For those looking to be pampered, this is the place! Guests are ferried to the hotel in either a Rolls Royce or a helicopter and each guest has a choice of 13 pillows on which to rest their heads.

But the largess is not just being spent at home on hotels and office towers, it is also being spent abroad. The swelling coffers of the Gulf region's sovereign wealth funds have been instrumental in bailing out the tattered finances of many of the world's largest investment banks.

With oil above $100 a barrel, an unparalleled economic bonanza is occurring in the Gulf region. According to the McKinsey Global Institute, if oil stays above $100 a barrel, the six nations of the Gulf Co-operation Council (Bahrain, Kuwait, Oman, Saudi Arabia, Qatar and UAE) will reap a cumulative windfall of $9 trillion by 2020.

While the economies of China, India and America may flourish on the hard work and ingenuity of its citizens, the opposite situation is what plagues the countries of the Gulf region. Blessed with geological serendipity, most native sons are all too eager to share in their countries' riches, while letting others to do the work.

In the Gulf, a liberal attitude toward guest workers prevails. In fact, foreigners hold 60% of the private sector jobs in the Gulf Co-operation Council ("GCC") region and a staggering 90% in the United Arab Emirates ("UAE") alone. For many of the Chinese, Filipinos and Indians who come to work as guest workers, the lousy pay and poor working conditions are a major issue. On March 18 th , hundreds of guest workers in the emirate of Sharjah went on a rampage, torching cars and buildings in a protest over pay.

Nationals, who choose to work, often settle for one of the many government jobs, available only to locals. Flush with oil revenues, the various GCC states create high-paying government jobs for their citizens. Unfortunately, many of these "government jobs" are nothing more than a make-work exercise and, as a result, many employees don't even bother to show up for work. According to McKinsey, as much as 25% of the government employees in Saudi Arabia, UAE and Bahrain are absent from work at any given time.

Unfortunately, the situation is likely to get worse. In spite of some of the lowest student-teacher ratios in the world, many young people in the Gulf region graduate without any marketable skills. In order to keep the population at bay, Gulf states buy social peace by doling out generous benefits and subsidies, such as cheap housing and medical care as well as expanding the government payrolls.

But all this government hiring is dependent on high oil prices. Not only that, but the populations of many of the Gulf states are set to soar over the coming decades pitting a two-tiered labor force against entrenched monarchies. Who will win is anyone's guess, but the region needs desperately to diversify its economies away from oil and toward technology in order to boost productivity and provide jobs for its young people.

Figure 1: The Gulf States Populations Roar, While We Falter!

(Population changes in millions of people)

The economies of the Gulf need to create some 280,000 jobs a year to employ the young people graduating from schools and universities, according to a study by McKinsey. To that end, Saudi Arabia has announced the creation of seven new economic cities, which it hopes will create millions of jobs for its restive youth.

Good luck! The region's track record in innovation and progress is spotty at best. Part of the problem is that most of the wealth is far too concentrated, ending up in the hands of the ruling elite and governments that dole it out as they see fit. In order to liberalize the economies of the Gulf, many state-owned enterprises will have to be deregulated and privatized.

But it's not just a pampered and indulgent populace that threatens the states of the Arabian Gulf. It is also the rising cost of goods (inflation) coupled with a weakening U.S. dollar. The cost of men and materials is on the rise, with inflation topping 8.7 % this past February in Saudi Arabia and a staggering 11.1% in Oman, an 18-year record. The cost of real estate and rent is soaring as well. In Dubai, rents rose some 30% in 2006 and another 17% last year. Making matters worse, is the fact that most currencies (except the Kuwaiti dinar) of the Gulf states are pegged to the U.S. dollar.

With the American greenback under pressure, the cost of imported goods not priced in U.S. dollars has been on the rise. This has only served to exacerbate the tensions between the foreign guest workers and the local elite as most foreigners are paid in dollars, which aren't stretching as far back home as they used to. But while the economies of the Gulf states and the U.S. may have parted ways, the monetary policies of the central banks haven't — all thanks to the currency peg.

With inflation on the rise, an accommodative monetary policy, restless guest workers and massive unemployment in the area's youth, the challenges for the Gulf region couldn't be greater. For now, the extraordinary wealth brought about by surging crude oil prices has managed to paper over many of the region's problems. The big question that the Gulf states face, is will the music stop before the oil runs out?

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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