The Triple Fall: Oil prices, the Saudi economy, and the status quo in the Middle East

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Photo: Associated Press.

As oil prices plummet, Saudi Arabia is facing a serious challenge in balancing its books. The manner in which the country reduces its budget deficit may upend the Middle Eastern state of affairs.

By Viktor Sundman

Few states are as involved in their immediate neighborhood as Saudi Arabia is. From its support of a wide array of rebel forces in Syria to its outright military intervention in Yemen today and in Bahrain 2011, it is an important actor in the region’s conflict dynamics. It is also an important financial contributor to countries such as Sudan, Jordan, and Egypt, ensuring the survival of non-democratic regimes in these countries. Saudi riyal, as the currency is called, is thus an important resource upholding the status quo in the Middle East. However, future cash flows from the Arab Kingdom is in danger.

The Saudi Arabian economy is heavily dependent on its oil industry. Up to 90 percent of its revenues come from oil, and it is the export of the black liquid that has financed both its foreign overtures and its lavish domestic spending. That makes the recent plummet in oil prices especially problematic. From a price of $110 a barrel in 2014, the prices are now in the $20s, and show little sign of resurging in the near future. This drastic decrease in revenues led to a swelling of the Saudi budget deficit to 15 percent of GDP in 2015, a deficit that has to be closed if the long-term stability of the economy is to remain.

Many experts have pointed at Saudi Arabia’s significant foreign reserves, which serve as a savings account that can be used in cases of budget deficit. The country has a staggering $650 billion in foreign reserves, money that should be able to keep the country going for a long time. However, sooner or later these reserves will run out if nothing is done about the budget deficit, and the foreign reserves has already fallen by about $100 billion. It is clear that Saudi Arabia will have to do something to reduce its deficit in a not too distant future.

There are essentially two ways of dealing with a budget deficit: increase revenues, or decrease expenditures. One obvious choice would be to decrease spending on Saudi Arabia’s foreign involvement, which continues to eat away at government spending. It is unlikely that the Saudi leaders choose this strategy: they see themselves as the champion of Sunni muslim nations, and given Iran’s recent reemergence on the regional scene after its deal with the West, they perceive the need to defend Sunni interests against the Shia as growing, not declining. As they commit to fighting Iran-supported troops in Yemen and Syria, there will be no room for spending cuts in this sector.

Domestically, there is more room for maneuver. Expenditures on new cars, furniture, and showcase projects for the ministries have been postponed, and stakes in state assets, for example in the national airline and in telecoms, are to be sold. Even stakes in Aramco, the crown-jewel of Saudi Arabia’s state companies with its exclusive control over the state’s oil industry, are under consideration for a sell, albeit enough stakes are to remain as to guarantee future governmental control over the firm. Moreover, to reduce running costs, subsidies on water, electricity and fuel have been cut, and there are plans to cut the number of employees in the public sector, which serves as a form of unemployment benefit and employs roughly two-thirds of Saudi workers.

Even with these proposed expenditure cuts, there is a need for increasing state revenue if the budget is to be balanced, as is the goal of Saudi leaders. To that end, petrol prices were raised by more than 50 percent on January 1st this year, leading Saudi citizens queuing to buy petrol at the end of December before the raise to $0.24/liter was implemented. Furthermore, Saudis will for the first time pay a value-added tax of 5 percent on non-essential goods. Saudi leaders have pledged not to introduce income or wealth taxes, but in order to stabilize the Saudi economy and move away from its volatile oil dependency, other sources of revenues need to be found. The VAT is simply not large enough to ensure the stability of the economy, and in the apparent absence of other options, a future income and/or wealth tax may be inevitable.

According to political science, the introduction of taxes may have significant political effects. When citizens pay taxes, they are incentivized to place further demands on their government on transparency and accountability, so they can monitor how their money is spent. This is the reverse implication of the resource curse, which states that states dependent on natural resource exports for their revenues, rather than taxing its citizens, often are non-democratic because there is no pressure from the citizens to democratize. With taxes this pressure should arise, as the citizens’ stakes in the government are larger, and they want to keep those handling those stakes accountable.

If taxes lead to a democratic Saudi Arabia, it is unlikely that they will continue to sponsor actors in the Middle Eastern region in the way that they are currently doing. True, democratic states are not always the champions of morality and decency that they claim to be in their dealings with groups and regimes of dubious character, a point that is especially relevant in current day Middle East. However, democratic states are more dependent on their constituents for support, and in the trade-off between reducing foreign involvement and reducing domestic spending, most can be expected to prefer a limited international role. A democratic Saudi Arabia would thus be less active in upholding the regional status quo, not because it would deem it immoral to take part in such activities, but because its citizens will want to prioritize domestic issues.

Without Saudi involvement, the current status quo of the Middle East will crumble. Authoritarian regimes will lose their financial base, giving the populations of their countries the opportunity to overthrow them and establish new regimes. Ruthless rebel groups would also see their support waning, which would alter the conflict dynamics and possibly give one side a clear advantage, which in turn increases the opportunities for ending the conflict. It is by no means certain that these developments would be positive: new regimes may be even more ruthless than current ones, and victories on the battlefield may lead to incredible hardship for the populations living there, especially if they have ties to the losing side. But it would be a change from the current, very destructive, balance of powers in the Middle East, and may be the key to moving the region forward and improving living conditions for its citizens.

The main question here is, of course, whether the proposed economic reforms actually will lead to a democratization of Saudi Arabia. This is unlikely in the short term – especially as leaders have pledged not to introduce wealth and income taxes, at least for now – but certainly not impossible, or even improbable. One should not forget that those European countries we now consider stable democracies were at one point stable autocracies, not very different from Saudi Arabia. If there is something to be learned from history, it is that no society is immune from change, and that developments that seem very unlikely at a specific point in time may be the future normal. The Saudi Arabian regime and its involvement in the Middle East may seem immutable now, but may be significantly altered in 50 years. My advice is to keep an eye on the price of oil, and how the Saudi economy is responding: it might be the key to shift the balance of powers in the Middle Eastern order.

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