Arab Wealth: Financial Versus Real Assets

Arab Wealth: Financial Versus Real Assets

Hazem El-Beblawi

With the advent of the first oil price shock (1973–1974), a new term, “petrodollars,”

emerged to denote the Arab financial wealth placed in the major financial

markets. Now, more than three decades later, the new term “sovereign wealth

funds” (SWFs) has been coined to refer to the same essential phenomenon.

In both cases, these government-owned funds attracted much attention and

were subject to heated debate in the media and elsewhere. The declared objective

of the debate in 1973–1974 was to ensure the “recycling” of petrodollars

to the financial markets with minimum disturbance, while today the debate

has become a sign of the growing concerns about SWFs’ political risks and


With the eruption of the financial and economic crisis in late 2008 and the

prompt support given by Arab money to ailing financial institutions in the

West, the whole topic of the SWFs has virtually faded out in the media. SWFs’

contributions to bail out some financial institutions were highly praised as a

positive factor for international financial stability.

In both 1973–1974 and 2008, the issue was debated from the viewpoint of

the Western countries. The Arab interests were hardly voiced. More than two

decades ago, I published an essay on the subject in which I claimed that placing

these surplus funds—petrodollars—in financial assets rather than investing

them in real assets was not in the best interest of the Arab oil-producing countries.

1 I would add today that investing these funds in real assets would also be

beneficial to the global world economy.

Real and/or Financial Facts

Notwithstanding the vital role of finance in modern economies, in the final

analysis, the real economy determines economic outcomes. Financial institutions

help facilitate and encourage—or their absence could obstruct—the

movements of the real economy. Yet it remains true that finance is subservient

to the real economy. Finance is but a mirror of the real economy—perhaps a

little more than just a mirror.

The emergence of petrodollars, and now SWFs, is only a financial phenomenon.

Unless such funds are transformed into real assets, sooner or later they

would be bound to disappear through various financial mechanisms.

Given the recent history of oil price increases and, accordingly, the emergence

of petrodollars and SWFs, we can distinguish three cycles:

l From 1974 to 1978

l From 1979 to 1985

l From 2004 to 2008

In all three cycles, there was a surge of oil surplus funds and, four or five

years later, a substantial erosion of these funds.

In the first cycle, high global inflation followed the first oil price shock of

1974. By late 1978, there was enormous shrinkage both in surpluses in the

states of the Organization of the Petroleum Exporting Countries (OPEC) and

in deficits of the member states of the Organisation for Economic Co-operation

and Development.

In the second cycle, the Iranian Revolution gave rise to a second oil price

shock in 1979, and oil surpluses reemerged. The Iran–Iraq War in 1980 consumed

a major part of these funds. In 1986, the world witnessed a shock in reverse,

with oil prices decreasing and stagnating through the end of the century.

During the same period, the first and the second Gulf wars exhausted a major

chunk of the remaining oil surpluses.

Finally, in the third cycle, oil prices surged sharply again in 2004, only to

come to a halt in 2008 after the eruption of a major global financial and economic

crisis. How can these developments be explained?

New Savers

The increase in oil prices over the last three decades amounts to a redistribution

of world income in favor of the oil-producing countries. The transfer of

wealth from oil-consuming to oil-producing countries is, perhaps, the most

significant consequence of the oil price increases. The sustainability of this

newfound wealth will depend on how the funds are put to use.

The principal oil-exporting countries, mainly on the Arabian Peninsula and

on the Gulf, were thinly populated and already enjoying relatively high per

capita income. With oil price increases, the Gulf oil-producing countries have

increased their share of world income, but more fundamentally this has led to

an increase in their propensity to save. The emergence of new savers—the oil producing

countries—is probably among the most important change among

recent economic developments.

The increase in the Gulf states’ share of world income permitted them to

boost their domestic spending spectacularly, both in consumption and investment.

However, because of the limitation on their domestic absorption capacity,

their excess savings remained unabsorbed domestically and were reflected

in huge balance-of-payments surpluses.

Sven Behrendt and Bassma Kodmani, Editors | 15

A new phenomenon, oil surplus funds, became a feature of the world economy:

excess savings in the form of balance-of-payments surpluses held by the

Gulf countries. Moreover, these new savings introduced a disturbing factor to

external global equilibria.

Placement—Not Investment

Perhaps the great merit of the ideas of John Maynard Keynes was to help build

macroeconomic models and to emphasize the importance of the ex post equality

between savings and investment. This is an accounting equality or, rather,

an identity, which holds true for every economic system regardless of the economic

forces behind it. One need not be a Keynesian to use this accounting

identity as a tool for analysis. For whatever determines savings and investment,

at the end of the day there must be an equality between realized savings and

realized investment. Theories may and do differ as to what influences both investment

and savings, yet all agree that the equality must hold ex post between


With the oil price shocks, the global economic system had to accommodate

the new savings (oil surplus funds) to the iron accounting equality savings =

investment. Economic forces should operate in such a way as to reconcile two

facts: the emergence of new savings, and the maintenance of the accounting

equality savings = investment.

Three possible scenarios can logically satisfy this requirement; thus, in the

face of the emerging oil surplus funds, there could be

l a parallel increase in the rate of real investment in the world;

l a nominal dissavings elsewhere in the world to offset the increase in the Gulf

states’ savings; or

l an increase in financial assets, giving rise to increased nominal investment


We therefore must distinguish between two kinds of transactions related

to financial assets according to their effect on the world economy’s productive

system: between investment and placement cases. By investment is meant the

use of finance to add to capital goods. The French term placement designates

the purchase of titles and shares that does not add to the productive capacity of

the economy. Placement adds only to financial assets.2

A combination of elements from the three scenarios outlined above is always

possible—and, indeed, is likely. Experience has shown that the third scenario

represented, to a great extent, the world’s response to the increase in its savings

(petrodollars). This does not preclude sporadic increases in real investments

(especially within the Gulf states themselves), nor a few cases of the transfer of

property titles (dissavings) to OPEC surplus countries. It remains true that, by

16 | Managing Arab Sovereign Wealth in Turbulent Times—and Beyond

and large, the rate of investment has not shown any perceptible increase with

the emergence of oil surplus funds. In fact, world real investment rates were

showing signs of slackening. Also, the transfer of wealth in the form of property

titles was the exception rather than the rule. On the contrary, financial

assets, particularly debt instruments (deposits, certificates of deposit, bonds,

bills, notes, loans, papers, etc.), soared dramatically in the aftermath of the oil

price shocks.

It seems to me that oil surplus funds were, to a great extent, used for placement

rather than for investment. The real question here, then, is how the

equality of ex post savings and investment could be brought about in this

placement case. The increase in financial assets, particularly debt instruments,

in the world economy triggered various economic forces that ultimately increased

the nominal investment (in value terms) to match the increase in the

Gulf states’ savings. It followed, then, that the Gulf states’ savings underwent

a continuous erosion until their virtual disappearance in 1978 after the first

oil price shock, and once again in 1985, after the second one. Finally, with the

collapse of the financial markets in 2008, a major part of the Gulf Arab states’

accumulated wealth evaporated.

To understand the workings of the economic forces that brought about the

required ex post equality in the “placement case,” it is helpful to recapitulate

the assumptions outlined above:

l No major worldwide reallocation between consumption and investment has

taken place, so that the old structure remained, by and large, unchanged

following the oil price shocks.

l OPEC’s new savings were not accompanied by a major nominal dispossession

of wealth elsewhere, so there was no substantial dissavings outside the

Gulf states.

l OPEC’s financial investments were largely added to—not subtracted

from—the total stock of financial assets.

Increasing financial assets without corresponding increases in real investment

contributed to the emergence of inflation in the late 1970s and early

1980s, and eventually to the collapse of the financial markets in 2008.

The Mirage of Security

It follows from the above discussion that the Gulf states’ savings placed with

the international financial markets amounted to an implicit, yet crucial, choice:

to place these savings with the industrial countries rather than with the lessdeveloped

ones. Injecting new financial funds (Gulf states’ savings) into the

industrial countries through international financial institutions would not,

Sven Behrendt and Bassma Kodmani, Editors | 17

by itself, increase real investment. The availability of financial resources does

not guarantee that real investment will be boosted in the industrial countries.

Nothing seems to augur a change in their effective demand toward more capital


The Gulf states’ savings were not, to be sure, voluntary savings acquiesced

to by industrial societies to finance new investment opportunities; they were

savings imposed on them by exogenous factors. If the proceeds of such external

savings were reinjected into the system, they would be immediately absorbed

with little real change in consumption patterns to restore the previous state,

the status quo ante. In these circumstances, it is not hard to understand that

the Gulf states’ new savings brought about a surge in financial assets without

much impact on the real economy.

It would, however, be farfetched to think that the profusion of the financial

assets and the proliferation of the financial markets came about merely due

to the emergence of the oil surplus funds. Far from that, various other factors

have contributed to this end. It remains true, nonetheless, that the oil funds

were an important element in this development.

Paradoxically, the Gulf states’ search for security, which led them to place

their savings in the most robust financial institutions, triggered a more menacing

danger that finally led to the erosion of these same savings. Shying away

from the hazards of investing in less-developed countries (LDCs) and preferring

more “secure” investments in advanced countries brought about much

more redoubtable risks.

Real Investment in and Partnership With LDCs

It would appear from the above that without increasing real investment to

match the increase in the Gulf states’ savings, the economic forces of the market

would, one way or another, work to erode the value of the new savings

(financial assets). This result was reached through general inflation, thus increasing

the nominal value of the financial assets owned by the new savers.

This was the case for the world economy in the late 1970s and early 1980s.

Subsequently, the same result came about through the collapse of the financial

markets themselves and the evaporation of a substantial part of the value of the

financial wealth. This is what we are witnessing in 2009.

Another crucial element that comes up here is the fact that the potential

for increasing real investment can mainly be realized in the developing world.

Only in the poor developing countries, the LDCs, is there a genuine need for

massive real investment. It seems paradoxical that the long-run viability of the

oil surplus funds is bound to the success of LDCs’ efforts to undertake massive

investment programs.

18 | Managing Arab Sovereign Wealth in Turbulent Times—and Beyond

A New Economic Order: A Dream?

Reshaping the international order and erasing world poverty have always been

the goals of the international community. Can the Gulf oil surplus countries

play a role in bringing about such a “New Economic Order”?

It would have been asking too much to expect that the Gulf oil surplus

countries would alone assume the whole responsibility for reshaping the world

economic order by investing their earned additional surpluses in the LDCs.

This is also highly idealistic.

The Gulf states’ new savings, it has been shown, cannot be maintained in

real terms without a parallel increase in real investment. And here emerges the

crucial role of the LDCs as potential partners for the Gulf states’ new savings.

Given structural demand limitations in industrial countries, only capital-hungry

poor countries would provide much-needed investment opportunities to

match the Gulf states’ newly available finance. This may sound too simplistic,

because investment in the LDCs is not only a question of finance—the LDCs’

institutional, human, and material shortcomings are too well known to warrant

any further elaboration.

Regardless of the formidable obstacles for enabling the developing world

to advance, there remains a basic difference between industrial and developing

countries with regard to the absorption of the oil surplus funds. In the

industrial countries, real investment will not increase without a corresponding

change in the domestic demand structure. In developing countries, on the

contrary, investment may increase—given the availability of OPEC finance—

without further need for a structural change in demand.

The picture can still be made brighter. Increased real investment in the

LDCs would imply more imports of capital goods from the industrial countries,

and hence a larger volume of international trade. The industrial countries

could thus increase their capital good exports to the LDCs to compensate for

their higher oil bills from OPEC (thus practicing trilateralism). The world as

a whole would become thriftier, yet more capital accumulation would also be

forthcoming. We could witness a higher growth path for the world economy

as a whole.

This, of course, is an idealized world. Real life is less attractive. The LDCs

are disappointingly mismanaged, lack skilled labor, and are deficient in infrastructure.

These are enormous problems and cannot simply be removed by a

stroke of the pen. However, the alternative has proved to be as depressing, if

not more so.

Additionally, even a hypothetical role for the Gulf states in establishing

a “New Order” will need a massive transfer of resources to the LDCs. It is

only by concentrating their investment effort in a particular region that tangible

results could be expected. Since the Gulf surplus countries are mainly

Sven Behrendt and Bassma Kodmani, Editors | 19

Arab states, a privileged region for a concentrated regional investment program

could have ideally been the Arab region. An Arab regional development plan

would thus appear, in theory, to be most promising.

Conclusion: Wealth Cannot Simply

Be Created by Financial Devices

Petrodollars and SWFs are no more than additions to financial wealth placed

in the financial markets in the form of financial assets. The increased savings

of the Gulf states did not bring about corresponding increases in real investment.

The emergence of these new funds was confined to the financial sphere

and barely touched the real economy. The failure to increase real investment to

match the increase in the Arab Gulf states’ savings triggered economic forces in

the market to work toward the erosion of these states’ accumulated wealth.

This is not a conspiracy theory, but it is the result of an obvious fact: Wealth

cannot simply be created by financial and/or monetary devices. Wealth can

only be created by adding to the real assets on the ground.

The mismatch between the financial and real aggregates led to financial turbulence—

first inflation, and subsequently the meltdown of the financial markets.

The Arab Gulf states can help themselves and the world at large if they

achieve a state of mind that focuses on real investments rather than obsessing

about financial wealth. The Arab region could become a promising land for a

massive program of investment. But it will take more than an academic exercise

to actualize such a dream. The Arab region needs a new vision, and more



1 Hazem El-Beblawi, “The Predicament of the Arab Gulf Oil States: Individual Gains

and Collective Losses,” in Rich and Poor States in the Middle East, ed. M. Kerr and S.

Yessin (Boulder, Colo.: Westview Press, 1982).

2 Joan Robinson, The Accumulation of Capital (New York: Macmillan, 1956).




Carnegie Middle East Center

Number 16 n April 2009

A joint initiative of

كارنيحى ابريل 2009





Carnegie Middle East Center

Number 16 n April 2009

A joint initiative of

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