Arab Wealth: Financial Versus Real Assets
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
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?
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.
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
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
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
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