Saudi Arabia-Economic Policy During the Oil Boom, 1974-85

In the early 1970s, the economic situation changed dramatically. Oil exports expanded substantially, royalty payments and taxes on foreign oil companies increased sharply, and oil-exporting governments, including the kingdom, began setting and raising oil export prices. Saudi Arabia's revenues per barrel of oil (averaged from total production and oil revenues) quadrupled from US$0.22 in 1948 to US$0.89 in 1970. By 1973, the price had reached US$1.56 and soared to US$10 and higher in 1974 following the Arab oil embargo introduced to pressure Western supporters of Israel during the October 1973 War. In 1982 the average export price per barrel of oil reached well above US$30. Between 1973 and 1980, government oil revenues jumped from US$4.3 billion to US$101.8 billion. At last the higher oil revenues gave Saudi officials the means to make major structural changes in the economy.

The society encompassed factions eager to promote the modernization program, as well as some elements within the royal family and the religious community who feared the social consequences of rapid economic transformation. Others, mainly from the technocratic elite, were concerned about the economic consequences of such a rapid expansion in expenditures. One choice facing policymakers in the early 1970s was whether to restrict oil production to a level that was adequate to finance limited economic and social development or to allow production at a level that would meet world demand for crude oil. Choosing a relatively high production level would force a decision on whether to use resulting revenues for rapid domestic economic and social development or long-term investments abroad. There were other policy choices. Those people who wanted to keep oil in the ground, except for that needed for limited development, argued strongly that this policy would best preserve the country's resources for future generations.

The choices appear to have been made by 1974 at the latest, although the decision-making process was not always clear or discernible. One issue was clear, however: domestic economic policy did not drive oil production and export policies. The Al Saud pledged to keep oil flowing at moderate prices, commensurate with world needs, arguing that the kingdom was as dependent on the stability and prosperity of consuming nations as those nations were on Saudi oil. Moreover, if Saudi Arabia wanted to ensure that oil would remain the energy source of choice, moderate prices were essential. In addition to framing the issue in purely economic terms, the decision had a geopolitical dimension: since World War II the kingdom had linked itself with the West and was eager to honor its pledge as a loyal ally on the international and regional level. This position was also reflected in its relations with Aramco. Saudi officials argued that the kingdom had avoided nationalization, opting instead for a gradual takeover of foreign oil companies operating within Saudi borders. Despite these attempts to moderate oil prices, the supply-and-demand fundamentals of the international oil market combined with the changes in ownership of downstream assets to raise international oil prices, creating enormous pressures on the domestic front to invest rising oil revenues in developing the country's economic and social infrastructure.

By the mid-1970s, the government had decided to use most of the growing oil revenues for a massive development effort. An important part of that effort was to industrialize, largely by investing in processing plants that used the country's hydrocarbon resources. This policy meant at least a decade of very large investments to build the plants and the necessary infrastructure. It meant financing and building the gas-gathering system, the pipelines for gas and crude oil to bring the raw material to the two chosen main industrial sites--Al Jubayl (or Jubail) and Yanbu al Bahr (known as Yanbu)--and building the industrial sites themselves. The development effort also included many other projects, such as the huge and costly airports at Riyadh and Jiddah, hospitals, schools, industrial and plants, roads and ports. By the mid-1980s the massive expenditures totaled US$500 billion.

The decision to increase the country's oil and gas resource development through downstream investments in refineries and petrochemical plants was logical considering the country's resource endowment. Three factors motivated such a strategy. First, downstream investments were capital-intensive, which fitted Saudi Arabia's small population and large oil revenues. Second, more value-added income would be extracted and retained, thereby maximizing Saudi revenues through the export of more refined petroleum products instead of crude oil. Moreover, the natural gas that had been largely wasted before the 1980s would be processed and used.

Third, some Saudi planners saw industrialization as another opportunity to widen the sphere of economic activity for foreign and domestic private firms. Participation of foreign private sector firms was crucial from the outset. Saudi Arabia invited several international oil companies to invest in joint ventures in the new export refineries built in the kingdom during the late 1970s and early 1980s. Furthermore, participation by international petrochemical companies was necessary to obtain the technology needed. There was also the issue of access to the markets of the West: Saudi planners anticipated regulatory and trade problems by exporting petrochemicals to markets that already had made substantial investments in the petrochemical industry. Saudi planners therefore hoped that, with the help of foreign multinationals, they could fit Saudi petrochemical output into international distribution networks.

On the domestic front, the state would build the basic industries, the crucial first step in the chain of industrial processing. Through loans and other incentives, the state would foster the growth of specific private sector industries that would be at the lower end of the industrial process. Over a period, the planners anticipated that the state-owned conglomerates might be partially privatized.

A large part of the funds spent on development programs were intended to promote private sector investment and to support future consumption. Starting in the mid-1970s, the government decided that an adequate infrastructure was essential to the kingdom's future development. Providing this infrastructure included revamping and building electricity, water, sewerage, desalination, and telecommunication systems. Moreover, it entailed creating airports and ports and laying a vast network of roads. In terms of generating and distributing electric power, the government assisted private companies building and operating its electricity network through concessionary capital loans and continuing operating subsidies. Apart from upgrading distribution facilities for water, the government built several desalination plants and drilled wells, built dams, and installed pumps. Telecommunications were quickly brought to international standards, allowing Saudi Arabia to handle all its communication needs in local and international telephone, telegraph, maritime, and television distribution services, via cable, satellite, and terrestrial transmission systems. Under King Faisal ibn Abd al Aziz Al Saud (1964-75), there was a massive increase in government spending on education to an annual level of about 10 percent of the budget.

Saudi planners also saw the need for a subsidy program to supplement direct government outlays. The major reason was income distribution. Although direct grants to average citizens would have been most efficient, the logistics involved would have been difficult. Conversely, waiting for the oil expenditures to reach this economic and social objective might have created additional social tensions. Therefore, the government adopted a widespread subsidy program for utilities, fuels, agriculture, social services (both private and public), the industrial sector, and several other areas. Beyond income distribution, the rationale of the subsidy program was the need to promote nonoil development through cheap loans, technical assistance, industrial and agricultural incentives, and preferential buying of domestic products by the government. The subsidy program was also designed to improve education and health services.

The massive development effort entailed many risks. The size of the effort and the technology involved required the participation of a huge number of foreign workers for a long period, with the potential of disrupting the society. The pace of modernization was also economically disruptive. Some observers questioned whether Saudi refineries and petrochemical plants would be efficiently managed and prove competitive within a reasonable time. By the early 1980s, the country encountered economic and social tensions--such as the inflation of the mid- 1970s, the takeover of the Grand Mosque in Mecca in November 1979, and disturbances in the Eastern Province in 1979-80--that dissipated only late in the 1980s.

Another risk of the massive development effort was the loss of control over expenditures or inadequate justification of investments. The sudden easing of financial constraints in the mid-1970s permitted consideration of projects too lavish or too large earlier. The forced development of the capital at Riyadh was a sentimental and political decision that required large expenditures to bring such necessities as water, electricity, communications, and housing inland to a capital far from the economic centers of the country. The huge airports at Riyadh and Jiddah (built at a reported cost of US$3.2 billion and more than US$5 billion, respectively) were architectural monuments, but whether they were a wise use of the patrimony of future generations was unclear.

The rapid rise of public purchases and contracts after 1974 caused foreign businessmen to flock to the kingdom. Because Saudi agents were usually essential, foreign businessmen frequently paid them large fees, to be recovered in the contract they were seeking. The Saudi business sector viewed these practices from a perspective different from that of some outside observers: agent fees and influence peddling were called corruption by visiting journalists but were judged less harshly domestically, although there was some unease. Some Saudis criticized agent fees frequently granted to the wealthy, especially people related to the royal family. The perceived costs, combined with growing criticism at home, eventually prompted the government to restrict the use of agents and fees on some defense contracts and to take other measures to control costs.

Looking back at this huge effort in the early 1990s after several years of stagnant public investment, the picture was mixed. On the one hand, the infrastructure had stood the test of time and provided the citizenry with world-class facilities. On the other hand, maintaining these investments, some of which lacked a direct financial payback, despite their more general economic uses, has been costly. More problematic may be the public perception that authorities, having fostered such dependency on government largess, found it extremely difficult to reduce services.

Several other infrastructure problems became apparent. First, the vast majority of expenditures were concentrated in a few cities, predisposing these metropolitan areas to more rapid economic growth. Second, infrastructural support systems were programmed at an early stage of the country's development, rendering some obsolete in the early 1990s. Third, some of the facilities seemed to have been built as an end in themselves, leading to unnecessary waste and continuing maintenance costs.

The most entrenched problem from the period of rapid development of the mid-1970s to the early 1980s stemmed from the government's willingness to subsidize production, consumption, and investment. The objectives for subsidies were threefold: encouraging nonoil economic activity, meeting social goals, and distributing income. The subsidy program may have created greater problems than were earlier anticipated. Saudi planners never thought that oil revenues would constrain expenditures to the extent that they did in the late 1980s and early 1990s. Efficiency requires that subsidies be applied directly at the source. Most Saudi production subsidies have been indirect subsidies, which have reduced the cost to consumers of electricity and other industrial inputs, leading to unnecessary waste. The industrial sector has thereby become a relatively inefficient producer and has made little effort to wean itself from government assistance.

Nowhere was this problem more prevalent than in the agricultural sector where national security was the original objective in raising output. Saudi Arabia became self-sufficient in several major food grains but the cost to the budget and the ecology could not be justified. First, international experience has shown that food embargoes have generally failed unless accompanied by a major military campaign. Second, savings on food purchased from overseas could easily have been invested in inventory to safeguard against an external threat. Third, no social benefit emanated from such a program. Agricultural employment continued to decline, and large conglomerates, rather than peasant farmers, profited from most subsidies. Fourth, subsidies could have been related to more appropriate production methods that promoted water conservation.

Data as of December 1992