February 7, 2012Uncategorized
Paper presented to the International Labor Organization Conference
Geneva – 3 June, 2009
The Arab Region and the Global Financial Crisis
It gives me great pleasure to be here to discuss the impact of the financial crisis on different regions of the world. I will confine my remarks to the region which I know better, i.e. the Arab region. However, I would caution that the opinions that will be expressed here are totally mine and do not, necessarily, reflect those of the organization with which I am associated.
Though sharing common historical and cultural heritage, economically the Arab region is not homogeneous. Two sub-groups stand quite distinctively, i.e., the Arab oil- exporting countries, particularly in the Gulf, on the one hand, and, the rest or the non – oil exporters on the other.
The first group is sparsely populated with abundant financial resources, thus enjoying high per capita income, while the second group is densely populated with low or medium per capital income. Both subgroups are negatively affected by the global crisis, though via different paths.
The present crisis, it has to be remembered, is a financial crisis in the first place, resulting from the collapse of the financial markets. The economic downturn is only a result of the failure of the financial system and its dysfunction. The essence of the actual crisis resides in the cancerous increase of toxic financial assets which undermined the soundness of the financial institutions, thus drying up liquidity and eroding the overall confidence. The financial markets were victims of the success of the financial revolution which gave rise to euphoric increase in financial assets not matched by a parallel growth in the real economy. This imbalance in the growth of the financial assets compared to the growth of the real assets disrupted the proper functioning of the financial system, i.e. the bloodline of the economic activity.
These preliminary remarks are fundamental to the understanding of the dilemma of the Arab oil exporting countries. But let us first draw a brief picture of the two subgroups of the Arab region.
The Oil Exporting Countries:
More than others, the Arab oil – exporting countries, particularly in the Gulf, bore the brunt of the actual financial crisis. First, the sharp fall in oil prices from close to $ 150 a barrel to less than $ 60 seriously affected governments revenues, thus reducing their surplus from some $ 400 billion in 2008 to an estimated deficit of $ 10 billion for 2009. It is important here to remember that the decline of oil prices was mainly due to the financial markets failure. These prices collapsed immediately after the eruption of the financial crisis and before the economic down-turn took a dent on the economic activity. The previous spectacular rise in the oil prices before the crisis was mainly due to speculations in future markets rather than to imbalances in supply and demand for oil. Therefore, it came as no surprise that oil prices nose- dived almost simultaneously with the collapse of the financial markets before the real economy started to show signs of weakness.
With the collapse of the financial markets, asset prices plummeted everywhere. The capital markets of the Gulf States, were no different. Thus, stock markets and real estates prices declined massively in the Gulf. This collapse negatively affected banks balance sheets, and, hence liquidity shortages erupted in the banking system. Also, some banks were highly leveraged and heavily dependent on foreign lines of credit, in Dubai in particular.
In the face of the crisis, most governments promptly intervened; central banks provided direct injections of liquidity into the banking system, supplemented by deposits from governments. Also, most governments in this group, provided guarantees for deposits (Kuwait, Saudi Arabia and UAE) and sovereign funds were requested to support the local stock markets. In the mean time governments’ expenditures were kept at high levels, unchanged from the pre-crisis levels. Most countries in this group maintained their investment expenditure at the same levels. Saudi Arabia has announced the largest fiscal stimulus with $ 400 billions plan over the next five years. The availability of large surplus funds allowed these countries to maintain high levels of expenditure to offset the downward trend in the global economic activity. In the meantime many Sovereign Funds participated actively in supporting many ailing foreign financial institutions in order to help maintain the international financial stability.
The overall result of the crises was a reduction in growth rates from the peak of more than 7 % to less than 3 %. Inflation rates were kept down, while the major losses affected their foreign financial wealth.
The Non- Oil Exporting Countries:
While oil- exporting countries were mainly hit by the financial aspect of the crisis, the non-oil exporting countries were more affected by the real economy down-turn. These countries are generally less financially integrated in the international capital markets. They were, however, negatively affected by the worldwide economic slow down. The prospects for exports, tourism, foreign direct investment and worker’s remittance deteriorated quite substantively. Also, they were not spared from the decline in the stock markets and have witnessed a serious down-turn in their capital markets. Nevertheless, they benefited from low fuel and food price decline thus improving their inflation prospects. The governments of these groups also provided support to their banking system, extending government guarantees to deposits in their commercial banks. Though they do not enjoy the same high levels of accumulated financial surpluses, their fiscal policies remained expansive in spite of their high level of domestic public debt. Many countries in this group have already witnessed a decline in their foreign reserves. The risk of higher inflation and /or foreign exchange shortage cannot be excluded.
Lessons for the Future:
Though it is too early to draw definitive conclusions from the present crisis, few lessons seem to be in order.
First and foremost is the recognition of the increasing world economic and financial integration. No country nor any group of countries can easily shield themselves out of the global crisis or rise above the fray. It is true that the Arab oil-exporting countries are more intimately connected with the international financial networks, but even the non-oil exporting countries could not absolve themselves from the global economic slow down. It is to be emphasized here that the impact of the crisis on the Arab non-oil exporting counties has been partially transmitted through their neighbors in the oil-producing countries, via workers’ remittances, Arab tourism and FDI. Thus, Arab regional integration reinforces global integration.
Secondly, the major loser of this crisis, were the oil- exporting countries, particularly the Gulf States. Their losses are not confined to a decline in their annual GDP, but their biggest loss is affecting their balance sheets with losses incurred in their accumulated financial wealth held in the major financial markets. These capital losses raise two related issues; the role of sovereign world funds (SWF) in financial stability, and, more generally, the future strategy for investing their surplus funds.
As for the role of the SWFs, there were heated debates and loud noises in the media and among high officials in Western countries as well as in international financial institutions about this role and the uncertainly about the management of these SWF’s. It was alleged that the SWFs lack sufficient transparency and that they are, more often than not, motivated by political rather than commercial considerations. The present crises has shown that these allegations are totally unfounded. Contrary to all predictions, the SWFs management acted, during the crisis, with a high sense of responsibility, promptly providing finance to ailing financial institutions. The SWFs were more a factor for stability than otherwise thought.
Thirdly, the future of oil surplus funds raises more strategic issues. The Arab oil –exporting countries, the Gulf states in particular, have a long history with the emergence and vanishing of the oil-surplus funds. We can summaries this history in these successive cycles;
– From 1974 to 1978
– From 1979 to 1985
– 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 same 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 of the oil producing countries and the corresponding deficits of the industrial importing countries.
In the second cycle, the Iranian Revolution gave rise to a second oil price shock in 1979, and accordingly oil surpluses reemerged again. The Iran-Iraq War in 1980 consumed a major part of these funds. During the same period, the first and the second Gulf wars exhausted a major chunk of the remaining oil surpluses. In 1986, the world witnessed a shock in reverse, with oil prices decreasing and stagnating through the end of the century.
Finally, in the third cycle, oil prices surged sharply for the third time 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?
Oil surplus funds, the main source of the SWFs, are excess savings of the oil-producing countries that could not be domestically absorbed. These savings are exchanged against financial assets issued by the oil importing countries and placed in the international financial markets. This is an exchange of real assets (oil), against financial assets.
The Economic history teaches us a good lesson. Mercantilist’s economists of the seventeenth century were obsessed with gold and silver, exactly as the oil surplus countries of the twentieth century are fond of financial assets placed in New York, London and Zurich. Adam Smith came to affirm that wealth can be created only by producing real commodities and not by accumulating gold or silver. Keynes also has taught us that the ex post equality between savings and investment must hold in every economy. The Arab surplus countries have to learn their lesson. Thus oil-exporting countries have a great benefit to make sure that their savings in the form of financial assets are matched by increase in real assets.
The failure to increase real investment in the industrial countries to match the increase in the Arab Gulf states’ saving (financial assets), triggered economic forces in the market to work toward the erosion of these state’ accumulated financial assets.
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 being obsessed by financial wealth. Opportunities of real investments in the third world are abundant.
One last point, the financial crisis which was brought by the excess of financial assets, is aggravated by an international monetary system based on a national currency, i.e. the dollar. The American balance of payments’ deficit is built-in the present Monetary System. Surpluses in the Gulf States and in China, for example, are the counter part of the American’s deficit. A more rational international monetary system could help reduce both surpluses and deficits, and eventually save the world from excessive financial assets.