Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Ragnar Nurkse's balanced growth theory wikipedia , lookup
Non-monetary economy wikipedia , lookup
Economy of Italy under fascism wikipedia , lookup
Rostow's stages of growth wikipedia , lookup
Post–World War II economic expansion wikipedia , lookup
Transformation in economics wikipedia , lookup
1 Economic Diversification in the Kingdom of Saudi Arabia A-M. M. Abdel-Rahman September 2001 6/19/2017 Department of Economics, King Saud University, Riyadh. 2 ECONOMIC DIVERSIFICATION IN THE KINGDOM OF SAUDI ARABIA A-M. M. Abdel-Rahman 1. INTRODUCTION The Kingdom of Saudi Arabia (KSA) possesses one of the largest economies in the Middle East and North Africa (MENA) region. Its Gross Domestic Product (GDP) reached US$ 185.3 billion in the year 2000. The real GDP growth rate was 1.2% in the year 1999, 7.6% in 2000 and is estimated to be 4.0% in 2001. The Saudi per capita income was US$ 6440 in 1999. The inflation rate calculated from the consumer price index was 0.0% in the year 1999, 2.6% in 2000, and is estimated to be 2.7% in 2001. The Current Account (CA) balance of the KSA was US$ (-)6.8 billion for 1999 but was at a surplus in 2000 with a US$ 7.0 billion. Merchandise exports were valued at US$ 69.5 billion in the year 2000 and were composed mainly of crude Oil and Petroleum Products; whereas merchandise imports were US$ 33.4 billion and were composed mainly of industrial goods, metals, and food. The merchandise trade balance for the same year was valued at US$ 36.1 billion. Oil exports revenues for the same time period were US$ 67 billion being up by 76% from their 1999 levels; thus the ratio of Oil exports revenues to total exports revenues was 96% in 1999. The major trading partners of the KSA in the year 2000 were respectively Japan, the United States, and the European Community. Budget deficits, were continuous from the early eighties due to falling Oil revenues and were at 11% of GDP in 1999. Within the context of a five-year plan, the KSA is aiming to achieve a balanced budget by the year 2005. Accumulated government debt for the year 1999 was high and estimated at $139 billion and reserves minus gold were at $17.0 billion. The accumulated public debt of the Kingdom is estimated to constitute about 115% of its GDP in 1999. The KSA’s economy is heavily dependent on Oil with Oil revenues making up around 90-95% of total KSA export earnings and around 35-40% of the country's GDP. Oil wealth has made possible rapid economic development, which began in earnest in the 1960s and accelerated spectacularly in the 1970s. Since then the Kingdom’s economic fortunes have been closely tied to that of Oil. Oil was discovered in Saudi Arabia in the 1930s, and large-scale production started after World War II. The KSA Oil reserves are the largest in the World, and the country is the World's leading Oil producer and exporter. Proven reserves are estimated at more than 260 billion barrels which constitute about one-quarter of World Oil reserves. More than 95% of all the Kingdom’s Oil is produced on behalf of the government by the 3 parastatal giant, ARAMCO and production generally varies in the range of 2.5 – 8 million barrels per day according to World demand, quota policies and other exogenous factors. Due to the sharp rise in Oil revenues in 1974, the KSA became one of the fastest-growing economies in the World. It enjoyed a substantial surplus in its overall trade with other countries, imports increased rapidly; and ample government revenues were available for development and aid to other Arab and Islamic countries. But higher Oil prices led to a backlash in the form of the development of more Oil fields around the World, the development of other energy substitutes, and reduced global Oil consumption. The result was a worldwide Oil glut that started to form in the mid 1980s. The KSA Oil production, which had increased to almost 10 million barrels per day during 1980-81, fell to a mere 2 million in 1985. Revenues dropped sharply introducing an element of uncertainty for the planning authorities in the Kingdom for the first time in a decade. Massive budgetary deficits ensued, and the government drew down its foreign assets to meet its ever-growing expenditure obligations. Responding to financial pressures, the KSA gave up its role as the "swing producer" within OPEC by 1985 and accepted the imposition of a production quota. Since then, the Kingdom’s Oil policy has been guided by a desire to maintain Oil market stability and quota shares. Beginning in late 1997, the KSA again faced the challenge of low Oil prices. Due to a combination of factors including the East Asian economic crises, and an increase in non-OPEC Oil production, demand for Oil slackened and pulled Oil prices down by over one-third. The KSA was involved in a series of Oil production curtailment agreements over 1998. This led to a sharp rebound in World Oil prices by early 1999 that continued – albeit with some fluctuations – to date. The rebound improved the country's economic outlook significantly, although the country continues to face both short and long-term pressures to liberalize and reform its economy and to open up to increased private investment1. 2. ECONOMIC DIVERSIFICATION This section evaluates the Saudi diversification experience based on Oil versus No-Oil considerations. The section starts with a description of the KSA’s diversification efforts using various indicators at the macroeconomic and sectoral levels. The section also considers the essential requirements for a successful 1 For more on these events see the sites http://www.eia.doe.gov and http://www.us-saudibusiness.org/economy.htm for example. 4 diversification drive in the country and highlights some diversification opportunities at the sectoral levels of the economy. 2.1. Macroeconomic Indicators: Despite early determined efforts to diversify its economic base and lessen its dependence on Oil through the increased development of a Manufacturing sector, the health of the KSA economy remains heavily dependent on the price of its single resource base which is Oil. Oil and Oil-derivatives account for over 90% of the Kingdom’s exports earnings, 75% of the budget revenues, and about 35-40% of its GDP. This marked dependence resulted in turn in an uneven and erratic economic growth path for the country as discussed below. Exogenous shocks such as the volatility and collapse of Oil prices, OPEC production ceilings, regional turmoil in the form of two consecutive Gulf wars, and World financial crises, have posed major challenges for the health of the KSA economy. To circumvent the impacts of these negative exogenous shocks on its economy, the Kingdom has set added diversification of its productive base as a high priority in its economic agenda. The objective is to broaden the economic base and opportunities in the economy, and to foster stable, balanced, and sustainable private sector led growth. The long-term goal and vision for the KSA economy is stated by the planning authorities in the Kingdom as: “…[…The attainment of…] a diversified and prospering private sector driven economy, on a growth path of sustainable development…”2. Through successively rolling 5-year development plans which started in the early seventies, the KSA government has sought to allocate its massive Oil revenues in a way that would transform its relatively undeveloped, Oil-based economy into that of a developed, structurally diversified modern form. Seven development plans have been initiated and implemented within the context of a comprehensive strategic framework the goals of which are reflected in a set of long-term general objectives that have been adopted by the government at the early stages of development planning in 19703. The objectives overall included variants of the following with some variation from one plan to another: improving the standard of living and the quality of life for the Saudi citizens; diversifying the country’s economic base and reducing dependence on the production and export of crude Oil; developing the KSA’s human resources; supporting the role of the private sector in the national economy; and achieving a balanced development path among the vast regions of the Kingdom. 2 3 Successive Five Year Plans, Ministry of Planning, Kingdom of Saudi Arabia. Achievements of the Development Plans (2000). 5 The KSA’s first two development plans emphasized infrastructure. The first plan covering the period 1970-1974 stressed diversification and industrial development and concentrated on Manufacturing, Mining, infrastructure development and import substitution. The second plan for 1975-1979 also emphasized diversification and the development of manufacturing industry. Foreign investment (FI) and technology were welcomed. The results for these two plans were impressive especially as regards to infrastructure development. The total length of paved highways tripled, power generation increased by a multiple of 28, and the capacity of the seaports grew tenfold. For the third plan covering 1980-84, the emphasis was regional diversification and self-sufficiency. Spending on infrastructure declined, but it rose markedly on services including education, health, and social services. However, the share for diversifying and expanding the productive sectors of the economy primarily industry - did not rise as envisaged despite the completion of the two industrial cities of Jubail and Yanbu, built to produce Steel, Petrochemicals, Fertilizer, and Refined Oil products in order to realize the intended industrial diversification objective. In the fourth plan, which extended over the period 1985-89, services in the form of education and training were given priority. Private enterprise was encouraged, and foreign investment in the form of joint ventures with Saudi private counterparts was stressed. Private investment increased in Industry, Agriculture, Banking, and Construction sectors where generous government financing and incentive programs spurred and supported these private investments. The fifth plan covering 1990-94 came in the advent of the second Gulf crisis, and predictably emphasized consolidation of the country's defenses. It also stated as objectives the provision of improved and more efficient government social services, regional development, and the creation of greater private-sector employment opportunities for Saudi nationals by reducing the number of foreign workers within what is came to be known as a program of ‘Saudization’. The roles of Manufacturing industries plus strengthening and deepening the inter-linkages in the economy – imperatives for the realization of the diversification objectives - were again stressed. The sixth five-year plan for 199599 focused on lowering the cost of government services and sought to expand educational training programs. The plan called for further reductions of the Kingdom's dependence on Oil by diversifying economic activity and for affecting the proper intra and inter-linkages between Manufacturing and the other sectors of the KSA economy. It also stressed the continuation of the efforts aimed at the "Saudization" of the labor force. The seventh five-year plan for 2000-2004 also emphasized lessening the dependence on Crude Petroleum and stressed further horizontal diversification in Services, Manufacturing and Agriculture. It also indicated the encouragement of 6 explorations and investment in Mining and increased private sector involvement in the social and economic development of the country. Economic diversification was thus a common recurring theme in all development plans. To gauge the success of these plans overall, we start by reference to table (1) below which illustrates the growth rates of some main indicators of the KSA economy over the last three decades covering the horizon of the successive development plans: Table (1) % Growth Rates of Major Indicators 1969-74 1975-79 1980-84 1989 1994 1999 Average GDP 14.6 7.8 -2.2 0.8 0.5 0.2 3.2 Oil GDP 17.9 2.9 -14.4 -1.8 0.2 -2.6 0.7 Non-Oil GDP 9.5 15.5 6.5 2.0 0.6 1.8 5.6 Manufacturing 11.6 15.2 15.2 4.0 1.8 5.2 8.1 Agriculture 3.6 6.9 10.4 7.0 0.7 1.4 7.5 Private Sector 9.6 14.8 8.4 1.4 0.9 0.2 5.8 Source: “Achievements of the Development Plans”, various issues. GDP real in producer values. From the above table it could be seen that that the average annual growth rate of GDP over the first six development plans covering the period 1970-2000 reached 3.2% at constant 1989 prices. Highest growth rates were achieved during the first plan with a 14.6% rate ushering the start of the developmental overhaul of the country. GDP growth rates fell markedly in the subsequent developmental plans and were indeed negative over the third plan period which coincided with falling Oil prices. Rates of less than 1% were recorded at the end of each of the fourth, fifth and sixth development plans. Oil GDP had its highest growth rate of 17.9% during the first plan and then tapered-off in growth and was markedly negative over the third plan - again in clear reflections of patterns occurring in World Oil markets. Non-Oil GDP increased more than five-folds during the same period, i.e. by an average annual growth rate of 5.6%. Growth in this component was highest over the second development plan where a 15.5% rate was registered. The contribution of Non-Oil 7 sectors in real GDP increased from about 42% by 1970 to about 62% by the end of the sixth plan 2000 in clear reflection of the drive for diversification of the economy. The average annual growth rate of the value added by manufacturing industries exceeded 8% during the past thirty years. Highest growth was over the first three plans in confirmation of the early drives for diversification and the priority given to the Manufacturing sector in that respect. Manufacturing growth stayed markedly positive by the end of the sixth plan with a 5.2% rate. The volume of agricultural production increased about six-folds in terms of value added from 1970 to 2000 and had its maximum growth over the third plan with a 10.4% rate. Growth in this sector subsequently subsided due to some water resource constraints. As for other sectoral distributions, the Private sector’s production increased by an average annual real growth rate of 5.8% during the entire period, surpassing the average annual growth rate of real GDP and replicating to a certain degree patterns recorded by the Non-Oil GDP component. Highest Private sector growth of 14.8% was recorded during the second development plan while the lowest rate of 0.2% was by the end of the sixth plan. The Private sector’s contribution to total GDP and to Non-Oil GDP amounted to 36.2% and 58.9% respectively, in the year 2000. Annual private investments rose from SR one billion in 1970 to about SR 64.3 billion in 1999, thus bringing the contribution of the Private sector to total fixed capital formation to 64.6% at current prices4 Overall then the results of the early development efforts were impressive with new productive sectors – particularly Manufacturing industry, and Agriculture accounting for a growing share of the economic activity in the country. The strategic economic goal of the authorities remains to consolidate its economic gains and to further diversify the country’s economic base and structure through the creation of high value downstream industries, and the freeing up of government resources for other sectors particularly the Private sector. 2.2. Sectoral Diversification of the KSA Economy: Business cycles in the KSA are mainly driven by supply-side shocks originating in the Oil market. Significant adverse shocks proved to be very destabilizing for the KSA domestic economy. The effects of these shocks did not limit themselves to the trough periods but generally spread over even to periods of boom. Anecdotal evidence of this could be cited in what has happened after the fall and recovery of Oil prices which occurred over the period 1997 – 1999. An initial slump in economic activity followed the fall in Oil prices which occurred in mid 1997 and over 1998. The KSA’s Oil export returns dropped 50% between 1997 and 1998 from US$ 42.7 billion to US$ 21.3 billion resulting in an increase in the ratio of the budget 4 Achievements of the Development Plans (2000). 8 deficit to GDP from 2.9% to 10.1% over the same time period. When the cycle was reversed and Oil prices picked up again by the first quarter of 1999, most of the revenue gains were targeted to pay off government debt accumulated during the trough period, and before thus leaving little surpluses to be spent on ways that would directly promote private sector expansion. To mitigate these destabilizing influences of adverse wide swings in Oil prices, economic strategy in the Kingdom has striven – with a certain measure of success - to diversify the economic base in the country from the start. Efforts towards diversification of the KSA economy were primarily directed at enhancing the roles of the Non-Oil and Private sectors in economic activities. Tables (2) and (3) below show the changing ratios of sectoral contributions to the GDP of the KSA at selected time periods which generally coincide with the end of the successive five-year development plans. Private sector’s share in nominal GDP increased from 23.5% in 1969 to 36.2% in 1999. This is compared to 26.3% for the share of Government sector in GDP in 1999. Private sector consumption in the same time period constituted two-thirds of total domestic consumption. The Private sector is also estimated to account for approximately a proportionate 73% of gross fixed capital expenditures in the KSA economy. Leading sectors of growth in the Private sector included Manufacturing, Services, Utilities, and Transportation and Communications. The share emanating from Manufacturing in particular has increased from only 1.8% in 1969 to 5.1% by 1999. Sector Oil Non-Oil Private Sector Government Sector Manufacturing Table (2) % Sectoral Shares/GDP* 1969 1974 1979 1984 56.1 65.3 51.9 26.7 41.5 33.3 47.1 72.0 23.5 19 26 43.5 18 14.4 21.1 28.5 1.8 1.6 2.2 4.9 Source: “Achievements of the Development Plans”, various issues. GDP current in producer values. 1989 29.2 68.6 41.8 26.8 5.1 1994 36.4 61.6 36.1 25.6 4.5 1999 35.3 62.4 36.2 26.3 5.1 The contribution of Non-Oil sectors to GDP is seen to have increased after an initial drop which occurred after the first Oil boom from 33.3% in 1974 to 62.4% in 1999 and is detailed in table (3) below. The Private sector’s share in Non-Oil GDP of 1999 stood at 58%, where the Manufacturing share in Non-Oil GDP in particular has increased from 4.3% in 1969 to 8.2% in 1999. The Government sector’s share was also stationary over the period and fluctuating in the narrow band of 39 – 45%. Efforts towards ‘privatization’ have recently accelerated and are designed to further boost the 9 share of the private sector in the economy. Sectors already privatized or are signaled for further privatizations include Telecommunications, Utilities – particularly Electricity – and Transportation. Sector Private Sector Government Sector Manufacturing Table (3) % Sectoral Shares/Non-Oil GDP 1969 1974 1979 1984 56.7 56.9 55.2 60.4 43.3 43.1 44.8 39.6 4.3 4.8 4.7 6.8 1989 61.0 39.0 7.4 1994 58.5 41.5 7.3 1999 58.0 42.0 8.2 Source: “Achievements of the Development Plans”, various issues. Within the Non-Oil sector itself there have been noticeable shifts in the relative distribution of GDP made by different sectors, as shown in the table (4) below. Most notable of these is that the Manufacturing’s relative share of total sector’s contribution to GDP increased from 2.2% in 1979 to 5.1% in 1999 while Agriculture’s share increased from 2.2% to 6.4% over the same time period. Crude Oil and Natural Gas shares fell dramatically from 48.1% to 33.3% of the GDP over the same time period which could be cited as evidence of successful diversification efforts intended to lessen Crude Oil’s shares in particular. Some services – particularly Trade; Transport, Storage and Communications; and Government Services also registered added shares especially in total GDP. Table (4) % Sectoral Contributions to Production Activities GDP Sector 1979 1999 Agriculture, Forestry and Fishing 2.2 6.4 Mining and Quarrying 0.4 0.5 Manufacturing 2.2 5.1 Electricity, Water and Gas 0.1 0.3 Construction 12.8 11 Trade 5.4 7.1 Transport, Storage, and Communications 5.0 6.4 Finance, Insurance, Real Estate and Business Services 5.3 4.9 Community, Social and Personal Services 2.4 3.1 Government Services 11.3 17.6 Crude Oil and Natural Gas 48.1 33.3 Source: “Achievements of the Development Plans”, various issues. Services include government services. NOGDP 1979 1999 4.7 10.3 0.8 0.8 4.7 8.2 0.2 0.5 27.2 17.6 11.5 11.4 10.6 10.3 11.3 7.9 5.1 5.0 24.0 28.2 - 10 The above developments were also accompanied by increased competitiveness on part of the Saudi industry in the face of severe import competition. During the Sixth Plan covering the period 1996-2000, productivity in the basic Petrochemical sector increased by 13%, and in other sectors such as Electricity, Transportation, and Telecommunication the increase ranged between 4 to 7%5. Other manifestations of the heavy reliance of the Saudi economy on its Oil resource base are to be found in the share of Oil revenues in total government revenues and the share of Oil exports in total export returns. Oil revenues traditionally constituted the major source of budget revenues for the government of the KSA. Though this share declined from more than 90% some 25 years ago, it nevertheless remains at a high level in the order of 70% of total government budget revenues. Table (5) below shows the share of different sources in these revenues. Sector Oil Revenues Other Revenues Table (5) % Sectoral Shares/Government Revenues 1969 1974 1979 1984 1989 90.3 94.1 89.6 66.2 66.2 9.7 5.9 10.4 33.8 33.8 1994 74.0 26.0 1999 66.7 33.3 Source: “Achievements of the Development Plans”, various issues. As seen in the data, there has been a steady increase overtime in the share of “Other” revenues in total government revenues mirroring a corresponding decline in Oil revenue shares where the share of “Other” revenues, including tax and non-Oil nontax revenues, increased from 9.7% in 1969 to 33.3% in 1999. An important component in this regard is the revenue generated from import duties which contributed a growing 7% share to total government revenues. This continuous increase in the “Other” share occurred despite a sudden surge in the contribution of Oil revenues over the year 2000 attributable to the rise in Oil prices over that time period. High dependence on the exports of the single Crude Petroleum commodity is a basic feature of the KSA economy and in turn is a direct derivative of the low degree of diversification in the productive sectors of the economy on the one hand and the high degree of openness of the KSA economy on the other. As noted before, Oil exports traditionally represent about 90%-95% of total exports returns. As further evidence of attempted diversification efforts, Non-Oil exports also witnessed a dramatic increase in their share of total merchandise exports. Table (6) below reflects this pattern where the share of “Other” products in total exports increased from only 5 See Bashir (1997) and Khemani (2001) for example. 11 0.2% by the end of the first development plan to about 16% towards the end of the 1990’s. Table (6) % Sectoral Shares/Total Exports 1974 1979 1984 1989 94.3 93.9 86.6 66.4 5.5 5.2 10.0 8.4 0.2 0.9 3.4 15.1 Sector Crude Petroleum Petroleum Products Other 1994 73.4 16.1 10.5 1998 67.2 17.1 15.7 Source: “Achievements of the Development Plans”, various issues. The share of Petroleum Products exports also increased threefold from 5.5% to 17.1% over the same time period in reflection of increased downstream sectoral value-added diversification mostly as a result of activities undertaken by the giant ARAMCO and the Saudi Arabian Basic Industries Company (SABIC) conglomerate under the government diversification program. Among the major commodity groups exported by the KSA significant increases occurred in the exports of Ceramic products, Glass and Glassware; Articles of Stone, and Plaster; Machinery, Mechanical and Electrical Equipment, and Appliances; and Optical, Precision and Surgical categories, etc… as shown in table (7) below. Year FBT TAL 1990 12.8 1.5 1994 12.0 1.7 1998 11.2 1.8 Table (7) Exports of Commodity Groupings WWP PPP CPP NMP BMI FMP OMI 0.8 3.2 50.2 6.2 4.4 18.4 2.5 1.4 3.3 45.2 10.3 3.3 20.4 2.5 2.1 3.5 40.0 14.1 2.1 22.6 2.5 FBT is Food Beverages and Tobacco; TAL is Textiles, Wearing Apparel and Leather; WWP is Wood and Wood Products including Furniture; PPP is Paper, Paper Products, Printing and Publishing; CCP is Chemical and Petroleum Products; NMP is Non-Metallic Products except Coal and Petroleum; BMI is Basic Metal Industries; FMP is Fabricated Metal Products and Machinery; OMI is Other Manufacturing Industries. Source: ESCWA (2000). Destinations of the country’s exports are also fairly well-diversified. Table (8) below shows the distribution of KSA exports by country groupings in the year 1999. Trade with the rest of the World also witnessed some diversification with respect to traditional trade partners. Recently, there have been significant increases in KSA bilateral trade particularly with other Gulf Cooperation Council (GCC) countries and China. 12 Table (8) % KSA Exports by Country Groupings Value in SR million Country Group Value Non-Islamic Asian 81118 North America 38467 Western Europe 31789 GCC 13310 Non-Arab Islamic 9696 Non-GCC Arab 5425 Non-Islamic African 5391 South America 2802 Australia and Oceania 1937 % 42.7 20.2 16.7 7 5.1 2.9 2.8 1.5 1 Source: Foreign Trade Statistics. Department of Statistics, various issues. In terms of the geographic distribution of economic activity in the Kingdom there is considerable concentration of economic activity in the three main regions of the country. 35% of the licensed operating facilities are located in the central region of Riyadh, followed by 27% in Mecca region, 23% in the Eastern Region, and 4% in Qasiem and Medina regions respectively. The above statistics thus provide broad indicators of the extent of diversification in the KSA economy. Despite its previous efforts, successes and failures, the Kingdom still faces considerable challenges in fostering the intended economic diversification. To accelerate diversification, successful strategies must be based on both comparative and competitive advantages where comparative advantage is based on endowed factor resources while competitive advantage has to be forged by increasing value-added economic activities conducted within the Kingdom’s firms industries, sectors and regions. 2.3. Diversification Strategies in the KSA: The intended goals of the diversification drive remain the reduction of risk and uncertainty, and the provision of greater economic stability as less reliance is placed on areas of economic activity that may be subject to business cycles and/or exogenous shocks. Diversification is also known to provide for positive spillovers between different types of economic activities in the form of economies of scale and scope, added inter and intra-linkages in industry and trade, diffusion of technology, and the attainment of organizational and managerial skills. It also leads to greater factor market flexibility for labor and capital. Diversification of an economy entails measures that firms and government consciously adopt to foster, maintain, and increase productivity on a sustainable basis. It relates to continual upgrading of 13 human and physical resources, and encouraging and strengthening inter- and intraindustry, sectoral, and international linkages. It requires inducing technological change, innovation, an open learning and knowledge sharing system, and change in the organizational structure and behavior of firms, industries, and government. Government has a principal role to play in facilitating this process by addressing systemic type of issues such as provision of efficient infrastructure, and other supportive business services. The measures undertaken to induce added diversification must be market oriented and aimed at various sectoral, regional and economy-wide levels. Competitive pressures, in both domestic and international markets, play a critical role and at the same time cooperation between firms and industries should be encouraged to develop general-purpose inputs, information, training programs, etc…. As discussed by Khemani (2001) a policy statement for diversification in the KSA should articulate a vision for an economy and component sectors which is efficient in investment and operation and supports industrial and commercial growth and social development. It should include public and private participation within the framework of an active and effective partnership module and should have a legal and regulatory framework that is conducive to private, and public sector participation. To forge a viable diversification and competitive enhancement program, an attractive climate for private investment must be created. To do that, it is necessary to adopt a liberalization and reform package which would include measures to allow the marketplace to function more properly, establish sectoral policy and strategy, and introduce competitive and stable fiscal rules. The package should also lay down an acceptable legal framework, provide supporting regulations administered by an impartial regulator, ensure transparency, avoid discrimination among investors, and preclude the use of an administrative bureaucracy to constrain investment activity6. For the economy as a whole and its constituent sectors the vision should be an open one with an enabling environment and a level playing field where the same rules apply for all i.e. public vs. private, local vs. foreign, corporate vs. individual. The traditional business-government dialogue and cooperation has to be transformed and promoted. Instead of businessmen seeking more subsidies and protection, tax-breaks and/or privileges, they would engage in a continuous dialogue with government on competitiveness and productivity impediments. Traditionally the private sector in the KSA was propelled by massive subsidies from the government. Table (9) below shows investment credit disbursed by the KSA government Specialized Financial Institutions to private sector and public corporations during the past three decades: 6 See Khemani (2001). 14 Table (9) Investment Credit Disbursed by the Government Billion SR Year 1969 1974 1979 1984 1989 Credit in Billion SR 16 871 19812 17551 5044 1994 7103 1999 4816 Source: “Achievements of the Development Plans”, various issues. Disbursements peaked in 1979 and then quickly tapered during the eighties and leveled during the nineties decade but still remain substantial. The global economy presents major opportunities in this regard for diversifying and upgrading the competitive position of firms and industries. Policies directed at de-regulation, privatization, trade and investment liberalization are giving rise to increased FDI flows as more flexible production systems, joint ventures, strategic alliances, and other cooperative arrangements in production and marketing take place. “It is firms and industries and not nations that compete against each other to gain market share. However, it is nations that have to primarily compete against each other to attract investment for their firms and industries”. Experience also suggests that high performance firms and industries are often part of a strong cluster7. Fostering industrial districts and clusters assists in realizing external economies of scale at industry level and in identifying where firms need to associate in order to provide and finance shared services, and to develop and implement strategies. Sectors amenable to cluster formation in the KSA include Tourism specially in the southern and western region of the country, Mining, and Information Technology specially in the Riyadh region because of the presence of a plethora of small and medium sized firms specializing in computer technology, software development, and training and tapping on the resources provided by a labor market pool, specialized suppliers and knowledge spillovers. 2.4. Possible Sectors for Diversification in the KSA: The basic messages given above focuses on creating an enabling environment for private sector development perforce including good governance, i.e. governmental policy-making marked by transparency, accountability, and credibility. Governments can do much to condition the business environment through an activist role by ensuring that appropriate legal-regulatory frameworks, market support institutions, and sound macro-micro economic policies are in place. Given the presence of this enabling environment, added diversification can be achieved by tapping the resources 7 A cluster is a system of market and non-market linkages between geographically concentrated firms and institutions involved in or supporting related economic activities. 15 available in additional candidate sectors of the KSA economy including Natural Gas, Mining and Tourism8. i. Natural Gas: The Natural Gas sector presents itself as a strong candidate for the added diversification program. The KSA’s proven Gas reserves are estimated at 204.5 trillion cubic feet, ranking fifth in the World after Russia, Iran, Qatar, and the UAE. Around two-thirds of Saudi Arabia's currently proven Gas reserves consist of Associated Gas, mainly from the onshore Ghawar field which alone accounts for onethird of the country's total Gas reserves. Most new Associated Gas reserves discovered in the 1990s have been in fields that contain light crude Oil, especially in the Najd region south of Riyadh. With domestic Gas demand growing rapidly, increasing Gas production is a priority for the Saudi government. Table (10) below shows production and consumption data on Natural Gas for the KSA for a selected number of years: Table (10) Production and Utilization of Natural Gas (Million Cubic Meters) Year 1970 1974 1979 1984 1989 1994 1998 Production 20625 47310 50561 25719 39052 54300 48880 Consumption 2261 6201 11695 23254 36719 37700 46820 Source: “Achievements of the Development Plans”, various issues. where it could be seen that production was largely domestic demand determined and tended to closely follow utilization since the mid-eighties. In response to increased domestic demand, a US$ 4.5 billion expansion of Saudi Arabia's Master Gas System was started in 1982 whereas previously, all of the country's Natural Gas was flared. In November 1996, a contract was signed for construction of a US$ 1.9 billion Gas processing plant at Hawiyah which represented the largest Saudi Gas project in more 8 For more on this see the site http://www.us-saudi-business.org/economy.htm 16 than 10 years, to be completed by the year 2002. In late 1999, ARAMCO decided to invest US$ 45 billion over 25 years on upstream Gas development and processing facilities. Additional Gas production is being encouraged as a driver and feedstock for the country's growing Petrochemical industry, as well as for electricity generation, desalination plants, and to expand the use of Natural Gas as an environmentally friendly fuel. Using Gas instead of Oil domestically will also help free up additional crude Oil for future export. The KSA is also considering allowing foreign investment in the Natural Gas sector to boost its diversification efforts in that direction. The vision for the Natural Gas sector is one of a sector that meets international standards in terms of cost competitiveness, quality of service, and protection of health and safety and the environment. ii. Mining: Another sector of great potential for the KSA economy is Mining. The vast country is home to the largest mineral resources in the Gulf region, including precious and base minerals, as well as industrial minerals. Minerals discovered in the KSA include phosphate, bauxite, gold, magnesium, gypsum, marble, iron ore, bentonite, copper, garnet, granite, graphite, high-grade silica sand, limestone, silver, and others. The Kingdom holds some of the largest phosphate deposits in the World. With private sector investment, the KSA can locally utilize the produced phosphate to consolidate its position as one of the leading exporters of fertilizers where anticipations are that the country will capture 16% of the World phosphate market. The KSA’s soil is also rich in bauxite and has the potential to supply the aluminum industry in the GCC region. Some estimates suggest that Saudi Arabia is home to 20 million tons of gold ore. The gold deposits have significantly contributed to meeting the needs of the thriving 2,000-ton domestic market, as well as that of foreign markets such as India, Europe, and the U.S. The KSA also has several iron ore deposits. The holding reserves are 84 million tons at 42.5% iron, which are sufficient for 25 years of pellet production at 2.2 million tons per year. The KSA is home to the World’s largest deposits of high-grade magnesite. The Kingdom’s soil is also rich in gypsum and marble which have a growing domestic market owing, in part, to an active construction industry. The development of the Mining sector occupies a prominent position in the Saudi Arabian diversification program. The KSA Mining sector is seen to present a high-growth potential, and the government views private investment as the mining sector’s engine of growth. An important catalyst for private investment in the Mining 17 sector was the creation of the Saudi Arabian Mining Company (Ma’aden) in 1997, with an initial capital of more than $1 billion. Ma’aden is involved in the development of the Mining sector through sole and joint ventures, and through its contribution to the development of the infrastructure of the mining sites, including water, electricity, and telecommunications. Incentives to the Private sector have contributed to making investment in the Mining sector highly profitable, both for local investors and their international partners. According to the Ministry of Petroleum and Mineral Resources, between 1990 and 1996, the profits of companies that had mineral franchises exceeded US$ 3 billion. Table (11) below shows the share of value added in mining to GDP as contrasted to Manufacturing during the nineties decade. Table (11) Share of Mining and Quarrying Year Mining and Quarrying GDP % GDP %Non-Oil GDP 1990 1812 0.5 0.8 1995 1882 0.5 0.8 1998 2022 0.5 0.8 1999 2082 0.5 0.8 Source: Achievements of Development Plans (2000). where the share of Mining and Quarrying to GDP and Non-Oil GDP remained constant at tiny 0.5% and 0.8% respectively over the decade despite the vast potential of the sector. The KSA government’s medium and long-term objectives for the sector include establishing industries for extracting and processing the minerals and making the country a leading exporter in that regard. Plans to develop integrated downstream cluster industries in the sector are starting to materialize. In 1996, a 160-ton design capacity refinery for gold, silver, and other basic products was set up at the Jeddah industrial estate. Challenges for the development of the KSA Mining sector stem from the fact that the global mining industry has changed considerably in the 1990s. The role of markets and the private sector has become the driving force whereas the role of the state has changed from owner and operator to regulator and administrator. Challenges facing the sector encompass reforms in public sector agencies and the establishment 18 of an enabling environment for long-term private sector participation in minerals. In terms of the public sector, the goal is to establish competent and responsive institutions which will serve to promote mineral investments and coordinate interministerial linkages, provide reliable geological and technical information, and administer mining cadastre and title registry. For the sector as a whole the vision is an open one with a level playing field with easy access to exploration rights thus minimizing state mining reserves and eliminating discretion in granting titles9. iii. Tourism: The Tourism sector also fits well into the frameworks needed for successful diversification and growth of the Saudi economy. The industry has a significant diversifying potential and is an excellent driver for national and regional development and employment enhancement through the creation of many Small and Medium-sized Enterprises (SMEs) in facilities and service areas in the economy. Recent studies, e. g. Sanford and Dong (2000) also suggest that tourism stimulates direct investment in a wide variety of industries, and subsequently gives rise to economic growth and development. In terms of economic potential, the tourism sector thus provides a strong candidate. International tourism is the World’s largest export sector, and is forecast to grow strongly over the next 20 years. The future prospects for tourism in the MENA region are excellent, and the area is projected to grow at 50% above the global rate up to 2020. In the context of the KSA, the Haj and Umra religious duties also provide a unique opportunity for the country. Table (12) below shows data on tourist numbers and expenditures in the KSA for a selected number of years: Table (12) Tourism counts and Expenditures Year 1994 1995 1996 Tourist Arrivals (1000) 3229 3325 3458 Tourists Receipts (US$ m) 1140 1210 1308 Domestic Tourism Expenditures (US$ m) Outbound Tourism Expenditures (US$ m) 1997 3594 1420 1998 3700 1462 2800 14200 Source: World Tourism Organization (2001), World Travel and Tourism Council (2001). The sector’s prospective importance for the KSA is clear given its significant untapped potential, its support for cluster sub-sectors such as hotels, food production, restaurants, transport, construction, trade, crafts, SMEs and others, its capacity for 9 For mire details see Khemani (2001) and UNCTAD (1997). 19 “backroom services” in services, finance and E-Commerce through such things as reservation systems, foreign exchange, travel insurance etc. To develop this sector, the Supreme Commission for Tourism (SCT) was formed in the year 2000. The vision was posited by the SCT as: “… to develop sustainable tourism for the socio-cultural, environmental and economic benefit of all….” A major concern of policymakers in the KSA is the continuous drain on the economy in the form of annual outbound tourism expenditures that exceeded to US$ 14 billion in 1998 as seen in the above table. Plans to reduce these leakages and to vitalize domestic tourism through promotion of religious tourism – which account for the majority of tourist arrivals - plus other forms of tourism, are well underway. But to develop tourism it should be first acknowledged that the KSA is currently weak in some of the essentials for international tourism development. The establishment of the SCT is a significant move to assess and plan a more forceful engagement with tourism as an economic diversifier. The SCT is currently preparing a strategic 20-year plan to develop sustainable tourism in the KSA. The strategic plan in turn encompasses a set of five-year action plans and a number of major bankable projects intended to activate development in this sector throughout the viable regions of the country. Changes are needed, however, to provide a platform to enable success, particularly in two areas covering easing the entry and visa regime and removing barriers to private sector investment in facilities. iv. Other Sectors: Development strategy in the Kingdom no longer assigns Manufacturing industry the leading role in bringing about a more diversified economic base 10. Indeed, services have outperformed industry in the race for diversification which implies placing a much heavier weight on the services sector in achieving development objectives. Tables (13) below shows the sectoral shares of services in GDP: Year % Services Table (13) % Sectoral Shares of Services/GDP 1969 1974 1979 1984 1989 15.6 12.8 18.1 28.8 25.6 1994 21.7 1999 21.5 Source: “Achievements of the Development Plans”, various issues. Services include Trade; Transport, Storage and Communications; Finance, Insurance, Real Estate and Business Services; Community, Social and Personal Services but excludes Government Services. 10 See, for example, the objectives of the Seventh Development Plan, Ministry of Planning (2001) 20 where the sudden surge in the Service share of GDP is attributable more to the fall in the Oil component of total GDP rather than to a dramatic increase in Services. This could be seen more clearly by reference to the Non-Oil component of GDP as given in table (14) below which shows the sectoral shares of services in Non-Oil GDP: : Year %Services Table (14) % Sectoral Shares of Services/Non-Oil GDP 1969 1974 1979 1984 1989 37.6 38.4 38.4 40.0 37.3 1994 35.2 1999 34.5 Source: “Achievements of the Development Plans”, various issues. where it is clearly seen that the Services sector contribute a substantial portion to the economic activity in the country but that their share in the Non-Oil component of GDP has remained roughly constant over the past three decades. Given the sheer volume of the KSA economy at the regional level, there is indeed scope for further growth in certain areas of the Services sector particularly those related to Trade and Finance where the Kingdom could play the role of a regional pole. Yet still other candidate industries capable of achieving added diversification in the KSA economy include Desalination, Textiles and Apparel, Information Technology and others. 3. FOREIGN DIRECT INVESTMENT AND ECONOMIC DIVERSIFCATION IN THE KSA This section focuses on the role basically played by FDI as an important catalyst for economic diversification in the KSA. The section considers first the cases for FDI in realizing the economic growth and diversification objectives and then proceeds to consider the features that make the KSA economy particularly conducive to FDI inflows. Trends in FDI flows are then described and analyzed, and their impacts on the domestic economy of the KSA are treated in a final subsection of this part. 3.1. The Case for FDI As noted above, despite the various success stories in the area of economic diversification in the KSA, there is still much to be done to accelerate the pace and increase the contribution of Manufacture and other sectors to production, income and employment. This is exactly the area where FDI can significantly contribute to broaden the productive base of the KSA economy and reduce dependence on its 21 single primary source of income thus serving as a vehicle to boost the diversification drive. FDI is an important source of capital for growth in developing countries. When carefully selected to meet development and growth targets and properly channeled to the appropriate sectors and industries, FDI provides a package of new technologies, management techniques, finance and market access for the production of goods and services; and by virtue of all that, it contributes significantly to raising total factor productivity in recipient countries and hence to their overall economic growth. FDI has positive impacts on domestic investments specially if theses flows are affected in industries with domestic forward and backward linkages. It would also lead to improvements in quality of domestic production and increased competitiveness domestically and internationally, and to increases in exports and improvements in the Balance of Payments (BP) of the recipient country. The induced increases in production and incomes will further spur domestic investments. These gains will in turn assist in broadening and diversifying the productive bases of the economy. FDI should be looked upon as one major tool in the country’s effort towards diversification and hence its ability to counteract adverse cyclical movements in Oil prices and smooth out fluctuations in its income stream. Historically, FDI in the KSA contributed to Oil explorations and refining and to the establishment of the Oil and Petrochemical conglomerates ARAMCO and SABIC. It also contributed to the development of Infrastructure and the Banking industry. The KSA started its process of enticing FDI inflows early by issuing the first Foreign Investment Law in as early as the Hijri year 1376H. This was followed by another Law in 1383H. A more comprehensive third Law was issued in 1399H (1978) which included wide-ranging incentives for investment and in 1421H (2000) a new Foreign Investment Law was enacted and a specialized investment institution – the Saudi Arabian General Investment Authority (SAGIA) - was set up to provide for the requirements that would permit an expanding flow of FDI into the Kingdom. The Foreign Investment Law provided the legal setting deemed requisite for enticing more FDI flows. One of the welcome features of the new law is its departure away from tariff incentives to other FDI-promoting measures in conformity with recent liberalization of trade and investment and the establishment of the WTO requirements. But the success of any country in attracting larger volumes of FDI depends critically on the existence of a specific set of domestic conditions believed to be imperative for a smooth and increasing flow of FDI. As far as these conditions are 22 concerned, the KSA economy presents itself as one of the better contenders for FDI as we briefly outline below. 3.2. Features of the Saudi Economy Conducive to FDI Inflows: The KSA has many economic and socio-political features that serve to entice FDI inflows to the country. Among those pertinent features are the following: The country is particularly endowed with natural resources and cheap energy sources. These constitute important sources of competitive advantage in the various economies. The KSA has about 25% of the World proven Oil reserves and produces about 12% of total World Oil output. It also ranks fifth in possession of World Natural Gas reserves. The availability of these resources makes the country in possession of one of the cheapest energy sources in the World. Since considerations of comparative energy costs are one of the principal influences on FDI flows, the Kingdom retains a remarkable advantage on this front. The abundance of other mineral resources also allows the country comparative advantage in a number of mineral-based industries and adds to the overall attractiveness of the KSA economy in competing for FDI flows. The rich resource base the Kingdom enjoys has historically made the country a natural habitat for foreign investments and as the Kingdom’s stock of natural resources remains still massive, it is expected that future utilization of these resources will also attract FDI in a fashion that will be dictated by future developments in technology and the business environment. It is also well known that a liberal economic environment is one of the most important factors influencing FDI flows. In this spirit, the conduct of economic activity in the Kingdom fully conforms to this requirement as it has consistently been carried out within the context of a free market premise. The consecutive development plans, have invariably emphasized commitment to a liberal economic framework as the most appropriate institutional framework within which development objectives are to be achieved. FDI flows are also known to be quite sensitive to the overall socio-political environment in the recipient country. Politically unstable countries pose greater risks of confiscation and/or nationalization of foreign-owned enterprises. Such countries may also place restrictions on capital mobility and the transfer of profits of foreign investors, thus adversely affecting the inflows of FDI. The KSA scores well in this regard given the marked degree of political and social stability that the country has been enjoying since its unification some 70 years ago. In terms of economic stability, the Saudi economy displays a number of attractive features as well. Inflation rates are low averaging only 0.6% during the period 1980-2000. This in turn preserves the purchasing power of the domestic 23 currency and insulates foreign investors from the adversities of an inflation-ridden economy. The domestic currency is pegged at exchange rate parity of 3.745 riyals for a dollar thus preventing any harmful exchange rate fluctuations from negatively impacting foreign investors. Domestic monetary policy in the KSA is generally conservative and is targeted to ensure stable prices and peg the exchange rate. Budget deficits as a ratio to GDP were brought down from as high as 25.3% in 1987 to as low as 2.9% in 1997 despite a transient increase in the ratio when it climbed to 10.1% in 1998 due to the drop in Oil prices following the Asian crises of 1997. But as the trend in Oil prices started to reverse itself in the first quarter of 1999, the deficit declined again until eventually a budget surplus was achieved in the year 2000. The external balance has also shown signs of improvement during the same period. The trade balance of the country was always in the surplus and the CA registered surpluses in 1996 and 1997 after an extended period of deficits starting in 1983. Such healthy performance in the internal and external balances of the country contributes to the stability of the economy and relaxes the constraints on government finances while mitigating the destabilizing influences of external imbalance especially on the exchange rate front. The KSA is also strategically located at the crossroads of major trading routes linking Asia, Europe and Africa with 8 ports serving the different parts of the World. The KSA has 25 major airports, over 45000 km of paved roads, more than 25000 mega watts of installed capacity of electric power generation and over 572 million gallons per day of desalinated water. The country has 8 industrial cities and there are plans for more. On the financial front, 10 commercial banks with 1196 branches provide modern banking services all over the country. These and other infrastructure facilities remove some major impediments to the production process. In addition to the above factors and in terms of the size of both the economy and the market, the KSA enjoys a clear competitive advantage over other countries in the region. The KSA has one of the largest economies in the MENA region. With total population estimated at 21.4 million in 1999 and per capita income of $6440, the Saudi economy possesses both a large market and strong purchasing power capabilities. The KSA, therefore, has the appropriate size and market features that are often cited among the most important factors behind the foreign investors’ decision on location. Moreover, the Saudi market is destined to widen even further in the near future upon completion of the customs union agreement involving the imposition of a Common External Tariff (CET) rate between the GCC countries, deferred from this year to 2005. Favorable implications of regional and international economic integration will also be fostered by the conclusion of the Free Trade Agreement between the GCC and the European Union, and the expected the KSA’s accession to 24 the WTO. All of these developments are expected to improve the investment climate in the country and to promote the KSA as one of the better locales for FDI in the region. 3.3. Trends in FDI in the KSA: Table (15) below provides data on FDI inflows to the KSA and their stocks. Data on inflows to the GCC region, developing countries, and to the World at large are also provided. FDI inflows are obtained mainly from UNCTAD and domestic KSA sources. Year 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 KSA Inflows 32.667 -22.889 -111.161 74.940 -627.371 -3733.521 1865.833 -395.751 781.020 536.261 -1269.265 -3191.163 6497.192 11133.061 4942.692 4988.036 516.064 1035.601 -1175.434 -328.972 -655.007 1863.551 161.282 -79.039 1369.025 349.800 -1877.170 -1128.972 Table (15) KSA FDI Millions of US$ GCC Stock 21828 20756 20746 20657 20637 22501 22661 22582 23951 24301 22424 21295 1912 -427 787 607 -768 -2788 6734 11385 4981 5243 715 890 1293 -2639 -121 367 355 1087 173 828 -900 1506 Dev. Co. World 8640 6940 6770 10290 4850 11230 20440 23320 15580 15300 12150 12080 14420 14940 18520 22200 41700 49620 73040 104920 111884 145030 22000 17000 26000 34000 43000 52000 57000 44000 49000 53000 48000 76000 110000 138000 182000 203800 158940 173760 218100 255988 331844 377516 25 1997 1998 1999 3048.064 4294.793 4806.409 24339 28628 33428 3601 4805 5452 178789 179481 207619 473052 680082 865487 Sources: UNCTAD – World Investment Report, various issues. A high peak of FDI is detectable in 1982 corresponding to the establishment of the giant conglomerate SABIC in the KSA. Troughs coincided with 1974, 1980 and 1995. An upward trend in FDI inflows could also be observed to have occurred since 1995 possibly due to the liberalization and opening-up efforts of the country. Table (16) lists the ratio of KSA FDI inflows to GCC, Developing World, and the World FDIs respectively. Year 1975 1981 1982 1983 1984 1985 1991 1994 1997 1998 1999 KSA/GCC 97.59 96.48 97.79 99.23 95.14 72.18 45.43 42.25 84.64 89.38 88.16 Table (16) Ratios of KSI FDI % KSA/Dev. Co. KSA/World 21.60 31.79 47.74 31.72 32.60 4.25 0.39 0.33 1.70 2.39 2.32 8.48 11.40 25.30 10.09 9.41 1.08 0.10 0.14 0.64 0.63 0.56 The fact that the Saudi economy continues to display features that are agreeable to FDI is validated by its share in FDI relative to other countries in the GCC region. The KSA has also drawn more FDI than any other country in the MENA region. Table (17) below shows FDI inflows to the GCC region disaggregated by country in million US$ for a selected number of years covering 1988-1999: Bahrain Kuwait Oman Qatar KSA 1988-1993 239 13 121 23 389 Table (17) GCC FDI Inflows (Million US$) 1995 1996 431 2048 7 347 46 75 94 35 -1877 -1129 1997 329 20 53 55 3048 1998 181 59 106 70 4295 1999 300 72 70 50 4806 26 UAE 111 399 130 100 100 160 Sources: UNCTAD – World Investment Report, 2000. Indeed, during the period 1975 -1999, FDI flows into the GCC region averaged about 3.6% of total FDI in developing countries as a whole and about 1% of World FDI flows. In 1999, the KSA attracted $4.8 billion of FDI while the amount of FDI that went to Egypt, the second largest recipient in the region at the time, was about $1.5 billion only. The KSA’s share in FDI received by all GCC member countries was 84.6% in 1997, 89.4% in 1998 and 88.2% in 199911. In more general terms, since 1995 there has been a continuous recovery of FDI inflows with an increasing trend both in absolute terms and as a ratio to GDP and gross domestic fixed capital formation (GDFCF), especially during the last three years of the 90s. Indeed, as the Table (18) indicates, FDI contributed a high 5.2% of GDFCF in the Kingdom in 1993. After a transient decline during 1994–1996, this share increased markedly from 1997 onwards. YEAR 1991 1992 1993 1994 1995 1996 1997 1998 1999 Table (18) Shares of FDI %FDI/GDP 0.2 -0.1 1.4 0.3 -1.9 -1.1 2.9 4.0 4.5 % FDI/GDFCF 0.7 -0.3 5.2 1.6 -7.5 - 4.7 11.1 16.6 18.1 Sources: UNCTAD – World Investment Report, 1997, 2000, Achievements of the Development Plans, 2000. 3.4. Impacts of FDI on the KSA Economy: As far as the sectoral distribution of FDI inflows in the KSA are concerned, the Manufacturing sector alone has attracted 90% of these investments while the remaining part was distributed among Services with a 9% share, Construction, Agriculture and Mining with a share of less than 1% for all. Operating factories licensed under the Foreign Investment Law totaled 474 in numbers constituting 14.3% of the total number of factories in the country and with total financing of US$ 35.2 11 World Investment Report 2000, UNCTAD 27 billion or 56% of the total financing available to the Manufacturing sector12. This large share is due to the fact that most of foreign investment is concentrated in the heavy Petrochemical industry with 129 firms in number with total financing of US$ 30.1 billion comprising 85.6% of total foreign investments in the KSA Manufacturing sector. In terms of sub-sectors of Manufacturing, the largest contribution of foreign investment was in the Chemicals and Petroleum Products category with a 74.8% share of foreign investment in total investments of that industry which indicates a heavy concentration of FI in that activity. This is followed by Fabricated Metal Products and Machinery with a foreign investment share of 28.6%; Nonmetallic Products with a share of 25.3%; and Paper, Printing and Publishing with a share in total financing of 24.5% as seen in table (19) below: Table (19) FI distributions in the Manufacturing Sector Activity Factories Total Employment Financing Total %FI Total %FI Total %FI Food and Beverages 529 7.4 16918 19.3 43534 15.2 Textiles and Apparel 156 10.9 3785 11.5 18220 9.7 Wood Product and Furniture 155 12.9 2324 11 13058 10.4 Paper, Printing and Publishing 205 9.8 6116 24.5 16231 18 Chemicals and Petroleum Products 670 19.3 15146 74.8 71056 36.2 Nonmetallic (construction materials, etc..) 560 10.4 25671 25.3 49849 21.2 Basic Metal 11 18.2 3947 3.2 2817 7.7 Fabricated Metal 915 19.8 23221 28.6 81652 22.7 Other 79 10.1 1373 30.7 6902 11.1 Transport and Storage 20 0 208.2 0 630 0 Total 3300 98709.2 303949 Source: Ministry of Industry and Electricity (2000), Faddli (2001). Industries which suffer from a dearth of foreign investment include Basic Metals; Wood Products and Furniture; Textiles and Apparel; and Food and Beverages. Conclusions that can be drawn from these observations are that foreign investment tended to concentrate in areas of mostly heavy industry. Added within-sectoral diversification could be achieved by proper channeling of foreign investment to industries deficient in foreign financing which are mostly medium-sized and light industries. Another result relates to the disproportionate small contributions of industries of high foreign investment concentrations to employment in the 12 See National Center for Economic and Financial Information (2000). 28 Manufacturing sector overall. The Chemicals and Petroleum Products industry absorbed almost 75% of the total foreign financing available to the Manufacturing sector but contributed only 36% to total employment in that sector. On the other hand Basic Metal industries which attracted a 3% share of Manufacturing total foreign finances contributed a higher disproportionate 8% share to sectoral employment. These observations point to the fact that more inter and intra-sectoral diversification in this regard could be achieved by channeling foreign investment to areas conducive to employment. Table (20) below illustrates the distribution of domestic and foreign investment between the different Manufacturing industries which could be regarded as an indication of the ability of those industries to attract foreign investment: Table (20) Domestic and Foreign Investment Distributions in the Manufacturing Sector Activity % No of Factories % Finance Domestic Foreign Domestic Foreign Food and Beverages 17.34 8.2 13.3 2.5 Textiles and Apparel 4.9 3.6 3.3 0.3 Wood, Product and Furniture 4.8 4.2 2.0 0.2 Paper, Printing and Publishing 6.5 4.2 4.5 1.1 Chemicals and Petroleum Products 19.1 27.2 37.2 85.5 Nonmetallic (construction materials, etc..) 17.8 12.2 18.7 4.9 Basic Metal 0.3 0.4 3.7 0.1 Fabricated Metal 26.0 38.2 16.2 5.0 Other 2.5 1.7 0.9 0.3 Transport and Storage 0.7 0.2 Total 100 100 100 100 Source: Ministry of Industry and Electricity (2000), Faddli (2001). Again the ratios tilt heavily towards the Chemicals and Petroleum Products sub-sector since it absorbed 85.5% of total foreign finances. This is followed at a distance by Fabricated Metals and Nonmetallic Products with shares of 5% each. On the other hand 37.2% of total domestic finance was allocated to Chemicals and Petroleum products whereas the shares for the Fabricated Metals and Nonmetallic Products two sub-sectors were respectively 16.2% and 18.7%. Inferences drawn from the above relate mainly to the disproportionate distributions of foreign investment between these industries since despite the fact that the ratio of establishments with direct and indirect foreign investment is 14.3% only of the total number, their share in financing is more than half of total financing allocated to the Manufacturing industries in the Kingdom. Foreign investment is also seen to be heavily concentrated in the Chemicals and Petroleum Products industries 29 with a share of more than 85% of foreign investment inflows to the Kingdom. Fabricated Metal provides the industry with the highest provisions for investment opportunities in view of the fact that 26% of the national establishments and 38% of the foreign establishments are in this sector. Lastly, it could be clearly seen that most of foreign investment flows were to capital-intensive projects and their contribution to employment within sectoral opportunities was generally minimal. 4. EMPIRICAL MODELS OF FDI IN KSA This part of the study presents various empirical models used to study causality flows from FDI to other important variables of the KSA economy relevant to the diversification issue and to gauge the determinants of FDI inflows themselves. Other relevant issues dealt with in this part relate to studying the possibilities of crowding out or crowding in between FDI and domestic investments in the Saudi economy which would have certain implications on the nature of policies directed at promoting investment and diversification in the country. 4.1. Causality Flows: In this section, we purport to determine causality flows between FDI, output, exports, and domestic investments in the KSA economy within the relevant sample periods. Causality flows are determined by application of Pair-wise Granger techniques to the respective variables. 4.1.1. FDI and Output: The relationship between FDI and output growth has been studied intensively in the literature. But as noted by the UNCTAD (1999): “The phenomenon of economic growth is complex and the lines of causation frequently go both from supposed causes to growth and from growth to the supposed causes. Furthermore, the various factors that are thought to explain growth are themselves interrelated…. [these problems] … apply to the study of the impact of FDI on growth. ”13 In the neo-classical growth models output growth is determined by the exogenous labor force growth and technological progress factors whereas FDI would have short-run effects only. The endogenous growth theory strand, on the other hand, studies the channels through which FDI can result in long-run economic growth14. One channel emphasized by Dunning (1993), Blomstrom et. al. (1996) and 13 World Investment Report, UNCTAD (1999). See also UNCTAD (1997), International Finance Corporation (1997) and Inter-Arab Investment Guarantee Corporation (1997). 14 See for example Grossman and Helpman (1991) and Barro and Sala-i-Martin (1995). 30 Borensztein et al. (1998) inter alia, works through a ‘catch-up’ process in the level of technology where FDI would result in capital accumulation in the recipient country hence encouraging the incorporation of new inputs and foreign technologies in the production function of the economy. A second channel works through knowledge transfers where FDI augments the level of knowledge in the recipient country through labor training and skill acquisition and through the introduction of modern management practices and organizational arrangements. This latter channel has been emphasized by de Mello (1997, 1999). FDI can also promote technology upgrading, in the case of start-up, marketing, and licensing agreements. It can also be seen as a catalyst for industrial development and technological upgrading and economic diversification. In this latter respect, Markusen and Venables (1999) presented an analytical framework of how FDI may lead to the establishment of local industrial sectors and clusters which may grow to overtake and force out FDI firms. As far as causation is concerned, the directions may not be that clear-cut. The arguments above support an export-led economic growth hypothesis. But on the other hand it could be argued that activity in the economy as measured by output growth clearly affects FDI inflows to that economy which would establish a direction of causation in the opposite way. Another possibility of bi-directional causality would occur if the recipient economy is working properly which would imply that the effectiveness of macroeconomic policies are crucial in making the economic environment attractive to foreign investors. In this regard the UNCTAD (1999) again report states that: “… what is fairly certain, without any implication as to causation, is that high growth rates and large inflows of FDI tend to go together.”15 Empirical studies designed to detect the flow of causation between FDI and output growth abound. Examples of these are De Mello (1997) and Ericsson and Irondoust (2001). Table (21.a) presents the results with respect to the KSA. Table (21.a) Pair-wise Granger Causality Tests FDI and Output Causality Flow Lags F-statistics 3 0.426 FDI ⇏ GRGDPN 3 3.140 GRGDPN ⇏ FDI FDI ⇏ GRGDP 15 p-value 0.736 0.048 GRGDP ⇏ FDI 3 3 0.733 2.529 0.545 0.086 FDISTK ⇏ GDPN 4 3.040 0.046 World Investment Report, UNCTAD (1999). 31 GDPN ⇏ FDISTK 4 1.838 0.168 * ⇏ Does not Granger cause. where the second column in the table contains the number of time lags used in the testing procedures. The third column contains the F-statistic of the Granger test and the last column its associated p-value. As can be seen from the table, the hypotheses that FDI inflows do not Granger-cause nominal output growth (GRGDPN) in the Saudi economy is accepted while that GDP growth does not Granger-cause FDI inflows is rejected at 5% level. The same picture holds true for causality flows between FDI and real output growth (GRGDP) albeit at a higher 8.6% level. The situation is reversed, however, when we deal with stocks of FDI where now the hypotheses that FDI stocks do not Granger-cause output in the Saudi economy is rejected while that of the level of GDP does not Granger-cause FDI stocks is accepted. The conclusion to be drawn from this is that the role of FDI in affecting more growth and diversification in the KSA economy has yet to be activated. 4.1.2. FDI and Exports: Inward FDI may increase host country productivity and exports and productivity growth in turn may affect exports. Pfaffermays (1994) studied the relationship between FDI and export growth and diversification using Granger Causality techniques in the Austrian economy. Other studies included Aitken et. al. (1997) and Ericsson and Irandoust (2001) where results generally remained conflicting on the lines of causation. Table (21.b) below presents the results with respect to the KSA economy. Table (21.b) Pair-wise Granger Causality Tests FDI and Exports Causality Flow Lags F-statistics 3 0.686 FDI ⇏ GREXP 3 2.829 GREXP ⇏ FDI FDISTK ⇏ EXP EXP ⇏ FDISTK 4 4 3.316 2.341 p-value 0.571 0.065 0.035 0.096 * ⇏ Does not Granger cause. In this instance the hypotheses that FDI inflows do not Granger-cause export growth (GREXP) in the Saudi economy is accepted while that export growth does not Granger-cause FDI inflows is rejected at 6.5% level. The situation is again reversed when we deal with stocks of FDI where now the hypotheses that FDI stocks do not 32 Granger-cause exports (EXP) in the Saudi economy is rejected while that of the level of exports does not Granger-cause FDI stocks is accepted at 5% level. In case of relaxing the level of significance to 10% then the test provides evidence of bidirectional causality between FDI stock and the level of KSA exports. The inference to be drawn resembles that for the output case. There is more scope for FDI to play in increasing the levels and diversity of the KSA exports. 4.1.3. FDI and Domestic Investment: Early studies on the links between foreign direct investment FDI and domestic investment (DI) included van Loo (1977) on the Canadian economy. More recent studies include Aitken and Harrrison (1999) and Kokko (1996) inter alia where the issue has been treated mainly within the crowding-out/crowding-in context as seen in the following section. Table (21.c) presents the causality results with respect to the KSA. Table (21.c) Pair-wise Granger Causality Tests FDI and Domestic Investment Causality Flow Lags F-statistics 3 3.168 FDI ⇏ DI 3 1.724 DI ⇏ FDI p-value 0.046 0.193 * ⇏ Does not Granger cause. where the hypotheses that FDI inflows do not Granger-cause domestic investment in the Saudi economy is rejected while that of domestic investment not Granger-causing FDI inflows is accepted at 5% level. This preliminary causality evidence thus points to a possibility of crowding in between FDI and domestic investment. 4.2. Determinants of KSA’s FDI16: We proceed next to present the model explaining KSA FDI inflows in terms of their various determinants. Conventional determinants of FDI inflows include the level and direction of activity in the recipient economy as measured by the GDP and its rate of growth, the degree of macroeconomic stability and openness of the economy plus the situation on its internal and external balances. Host country sociopolitical characteristics such as government stability, the legal system, and the extent of corruption, have also been suggested as explanations for differences in the extent of FDI inflows. An economy would entice more FDI inflows once it has implemented monetary and fiscal disciplines to control inflation and remove imbalances, 16 For models on determinants of FDI see for example Wang and Swain (1995), Chein-Hsun (1996). 33 liberalization reforms, and has promoted trade and provided the necessary institutional frameworks. An estimable FDI function could thus assume the following form: FDI f ( X,Z) f (GDP, GRGDP, OPEN , DI ; Z) where X is a vector of economic determinants which would include the level of GDP and its growth rate (GRGDP); the degree of openness of the economy (OPEN); and domestic investment DI reflecting the investment climate in the country. Other components of economic determinants could include the annual inflation rate (INF) calculated as the percentage change in the consumer price index; the budget balance as a Percentage of GDP (BDGDP); and the current account – or the trade balance (TB) - as a percentage of GDP (CAGDP). Z is a vector of risk variables where risks are mainly sociological, and political. Risk is measured by assigning risk points to a pre-set group of factors, termed the socio-political risk components. The subcomponents in the case of the KSA include government stability (GOS) which is a measure both of the government’s ability to carry out its declared programs, and its ability to stay in office; socio-economic conditions (SEC) which cover a broad spectrum of factors ranging from infant mortality and medical provision to housing and generally measures the degree of public satisfaction with the government; the investment profile (IVP) which is a measure of the government’s attitude to inward investment as determined by four sub-components which are respectively the risk to operations, taxation, repatriation, and labor costs; corruption (CORP) which is held to be a threat to foreign investment since it distorts the economic and financial environment, reduces the efficiency of government and business by enabling people to assume positions of power through patronage rather than ability, and introduces an inherent instability into the political process; law and order(LOD) where the two are assessed separately, with the Law sub-component being an assessment of the strength and impartiality of the legal system, while the Order sub-component is an assessment of popular observance of the law; and bureaucracy quality (BUR) since the institutional strength and quality of the bureaucracy tends to minimize revisions of policy when governments change. The data on these variable covers a limited range extending over 1984 – 1999 and is obtained from the International Country Risk Guide (ICRG) published by the PRS Group17. 17 For more on this, see the PRS (2000). 34 In our regressions we first used the individual risk components as regressors in combination with the various economic determinants but because of degrees of freedom problems due to the limited sample range, we resorted to use a composite risk rating regressor constructed from the individual components thus economizing on the number of regressors. The method of computing the composite socio-political risk ratings (CPR) consists of simply summing the various political risk ratings where the highest overall rating indicates the lowest risk, and the lowest rating indicates the highest risk. The above model was estimated where investments are taken in ratio forms to GDP by OLS methodologies and the results are given in table (22) below: Table (22) fdiyt β0 β1 gdpt β2 grgdpt β3inf t β4opent β5 diy β6 cpfrt β7 fdit i ... εt Variable C gdp -32.262 0.037 ( 3.011) Coefficients -33.881 -31.853 0.037 0.037 ( 3.049) ( 2.665) 0.125 grgdp 0.490 ( 1.997) 0.523 ( 2.168) [ 0.077] open 0.178 ( 2.247) (1.259) 0.488 ( 1.871) cpr 0.537 ( 2.277) 0.158 (1.939) 0.177 ( 2.080) ( 2.048) 0.619 ( 2.570) 0.514 [ 0.150] [ 0.149] 0.332 (1.594) 0.379 0.430 [ 0.149] [ 0.1137] fdi1 (1.642) 0.523 [ 0.101] ( 1.598) 0.143 [ 0.145] 0.435 ( 1.824) 0.518 [ 0.098] [ 0.089] diy ( 2.527) 0.150 (1.188) inf -30.829 0.034 ( 1.651) (1.622) ( 1.260) 0.021 0.176 ( 0.070) ( 0.550) R2 R2 ̂ F 0.626 0.418 1.365 3.015 0.682 0.444 1.334 2.862 0.626 0.346 1.447 2.235 0.695 0.391 1.397 2.283 d 1.409 1.387 1.432 1.476 [ 0.072] [ 0.086] [ 0.145] [ 0.149] where R2 is the coefficient of determination, R 2 is its adjusted version, is the standard error of the regression, d is the Durbin-Watson statistic and figures in parentheses are t-ratios while those in squared brackets are p-values. The fits of the individual equations were good as judged by the relatively high R 2 and R 2 measures. As far as the results are concerned, it is seen that GDP levels (gdp) affect the FDI to GDP ratio (fdiy) ratio positively, significantly and in a robust fashion through 35 alternative static and dynamic specifications. The GDP growth rate (grgdp) exercised a positive – though insignificant – role on the ratio. Inflation (inf) was another robust determinant of the FDI ratio where it exerted the expected negative effect throughout. Openness of the economy (open) was significant mostly and possessed the expected positive sign. The ratio of domestic investment to GDP (diy) proved to be a consistent positive determinant of the FDI/GDP ratio fdiy and had a higher significance in the case of the static formulation. The socio-political risk variable cpr proved insignificant for the attempted trials which could be attributable to the smallness of the sample and the low level of variation witnessed in the variable during the sample period of the study. The lagged fdiy variable was significant in the dynamic trial but only at 10% level. Overall then, it could be argued that the determinants of FDI inflows to the KSA economy are primarily economic in nature and relate in particular to recent levels, rates of growth in the Saudi economy and other variables relating to the macroeconomic climate in the country and its degree of openness. 4.3. Crowding-In and Crowding-Out Between FDI and Domestic Investment: The question whether FDI will hamper or spur domestic investment remains an open issue in the context of the KSA economy. If FDI is found to play a depressing role on domestic investment and in view of the concentration of FDI in the Chemicals and Petroleum Products sub-sector of Manufacturing then FDI may hamper the diversification efforts in the economy of the KSA. If on the other hand FDI is proven to play a motivating role on domestic investment, then this may boost the diversification efforts expended in the KSA economy. The question is thus an empirical one with certain implications for the diversification issue. In this section we tackle the question through the deployment of conventional models in this arena of crowding-in/crowding-out. Studies undertaken to resolve the crowding-in/crowdingout issue include Kokko (1996) and Aitken and Harrison (1999) inter alia. Two basic models are used in this context. The first model is a version of the conventional Solow growth accounting model and has been used intensively in the literature, e.g. by Karass (1996), and Odedokun (1997) inter alia to study issues pertaining to crowding in/crowding out. The model rests on a neoclassical production function of the form: Y F ( N , Kd , K f ) where N is employment, K d is domestic capital stock and K f is foreign capital stock. Application of derivatives plus some manipulations lead to the following formulation: 36 dK f Y F 1 dN F 1 dK d F 1 N Kd Kf Y N Y Ndt K d Y K d dt K f Y K f dt K f N K MPK d d MPK f N Y Y N I FDI d d f N Y Y where the last expression provides the estimable form of the model: yt n nt d diyt f fdiyt t The hypotheses to be tested are respectively: i. H 0 : f 0 which implies that FDI is not productive in the KSA, ii. H 0 : f 1 which implies that FDI is neither over-provided nor under-provided, and iii. H 0 : f 0; d 0 which implies crowding-out, or: ii i. H 0 : f 0; d 0 which implies crowding-in. Results are listed in the equation below which also adds a dummy variable D814 to stand for uncharacteristic FDI inflows during the time period 1981-1984: y t 3.863 2.616 nt 0.465 diyt 0.742 fdiyt 12.299 D814 (3.674) R 2 0.547 ( 1.946) (1.671) [ 0.0 6 6] [ 0.1 1] R 2 F 6.028 [0.002 ] 0.456 ( 3.500) ˆ 4.432 d 2.706 Results obtained for this type of specification indicate the acceptance of the first hypothesis in that FDI is not significantly productive in the Saudi economy in terms of its overall impact on GDP growth although that result could be relaxed if we are prepared to accept an 11% significance level. There are also indications that it is underprovided since its coefficient is less than one and that there is some sort of crowding-out between FDI and domestic investment since the coefficient on the DI 37 variable was negative at impact. Results obtained from this model thus tend to corroborate those of the causality tests in the case of the effects of FDI on output growth in the KSA but on the other hand tend to conflict with these on the possibility of crowding-in. The second model is similar to a model deployed by the UNCTAD (1999) in its annual World Investment Report to study the issue. The UNCTAD model starts with a simple equation where investment is the sum of domestic investment (DI) and FDI: I DI FDI From the point of view of the recipient country FDI is exogenous while domestic investment depends on a multitude of determinants. The UNCTAD version uses the growth rate which proxies the capacity utilization rates as a primary determinant of DI. The model justifies this by noting that the results regarding crowding-in or crowding-out are generally quite robust to different model specifications and hence only those stemming from the simplest of models should be used and reported. The UNCTAD model is thus basically an accelerator model of domestic investment of the following form: DI y By substitution, the model for total investment is: I y FDI to account for possible macroeconomic externalities affected by FDI on domestic investment a more general formulation of the following form is used: I y FDI where the hypotheses stemming from this model are: i. H 0 : 1 which implies crowding-out, or: i. H 0 : 1 which implies crowding-in. An operational form of the model - which introduces lags inherent in investment decisions and traditionally attributable to the various technical, institutional, and legal factors - assumes the following shape: ( L) iy ( L) y ( L) fdiy 38 The model thus enables short and long run effects to be taken into account where iy is total investment to GDP ratio; (L ) , (L) , and (L ) are lag polynomials of appropriate lengths. Both short-run and long-run crowdingout/crowding-in effects are tested where long-run effects are measured through the computation of the following statistics: ( L) ( L) and the testing procedure then proceeds by application of a suitable Wald-type test. Estimation of the model was undertaken within a general to specific modeling methodology and results obtained on trials with the total investment ratio on the LHS are given in table (23) below: Table (23) ( L) iy ( L) y ( L) fdiy Variable C grgdp 19.700 0.175 (1.231) Coefficients 18.026 11.548 0.279 (1.959) 11.235 0.103 (1.023) [ 0.066] grgdp(-1) 0.181 (1.246) 0.303 ( 2.020) 0.210 0.202 [ 0.060] [ 0.071] (1.988) (1.906) grgdp(-4) 0.027 0.103 0.074 0.060 fdiy 1.753 1.914 1.573 1.611 fdiy(-1) 0.576 0.556 0.396 0.399 ( 0.202) ( 7.121) ( 2.505) ( 0.969) ( 7.802) ( 0.987) (8.765) ( 0.791) (8.799) ( 2.546) fdiy(-2) 0.343 fdiy(-3) 0.361 (1.541) (1.451) iy(-1) ( 5.345) ( 5.390) R2 R2 ̂ F 0.782 0.728 3.461 14.378 0.826 0.759 3.259 12.233 0.877 0.854 2.536 37.542 0.883 0.854 2.533 30.311 d 0.699 0.940 1.187 1.196 2 16.955 18.479 17.066 17.356 [ 0.000] [ 0.000] [ 0.000] [ 0.000] [ 0.000] [ 0.000] [ 0.000] [ 0.000] Results obtained in these successive trials now indicate that first period lagged GDP growth affects the total investment ratio iy positively and significantly. The FDI 39 ratio fdiy exerted the expected positive effect and was robust in its performance throughout. The lagged total investment ratio iy was also highly significant in the dynamic specifications tried. As far as the results of the 2 Wald test on the hypothesis of equality to one, the results indicate rejection throughout and since the value of the fdiy was greater than one in the static and dynamic specifications, then we could infer the presence of crowding-in between foreign and domestic investment both over the short- and longrun, thus corroborating the previous results obtained via the Granger causality tests. More FDI is thus a lever for more domestic investments, productivity, output growth and diversification in the KSA economy. 40 CONCLUSION The paper reviewed past efforts undertaken to diversify the KSA economy and broaden its base. Various macroeconomic, sectoral and industry indicators were examined to gauge the success of the attempted policies. It was seen that despite the various achievements on this front much remains to be done. Policies to induce added diversification and competitiveness in the Saudi economy were reviewed and discussed and candidate sectors to be developed within the diversification drive were identified as Natural Gas, Mining, and Tourism. Foreign Direct Investment was seen to possess the potential as a mechanism and appropriate vehicle to induce the intended diversification of the Saudi economy. Trends in FDI inflows to the KSA were examined and issues relating to causality flows between FDI and the various parts of the economy were traced. The important issue of crowding-in/crowding-out between FDI and domestic investment were also examined through the use of some appropriate conventional models. The paper notes that fostering future diversification and competitiveness of the KSA economy requires an integrated or comprehensive strategy, involving an active partnership between the Private and Government sectors. The government has to play a facilitating role since successful strategies have to address systemic and economy wide problems faced by the economic agents at their various levels of operation. The private sector has to play the leading role in implementing strategies to upgrade capabilities. Private production of “public-type goods” in such areas as information, export promotion, financing, training, and productivity enhancement techniques will need to be initiated in a coherent framework. Some preliminary recommendations include the formulation of Action plans to address various private and public impediments to improving productivity and competitiveness that need to be formulated and implemented at different levels of the economy. In this regard, it is recommended that the industrial cluster approach towards increasing productivity and competitiveness be adopted. The government role is to deepen and accelerate policies aimed at strengthening the role of the Private sector, export promotion, attracting FDI, regional and international economic and trade initiatives, establishing an appropriate legal-regulatory framework and other measures undertaken to improve the business environment in which KSA firms operate. As far as the specific roles played by FDI in this diversification drive it was noted that FDI would have to be viewed as the most effective vehicle for economic diversification. A stable flow of FDI requires commitment to a long-term strategy designed to improve the investment climate but flexible enough to accommodate new developments. Investment policies should also aim at attracting FDI into Tourism, Mining, Infrastructure and Utilities where these areas, which are ideal candidates for 41 diversification, have high linkages with the rest of the economy. Furthermore, care should be taken so that FDI does not crowd-out private domestic capital from the activities it currently engages in. In a related vein, removing or minimizing restrictions on foreigner’s access to different sectors in the economy is imperative for encouraging added FDI inflows. In this respect, narrowing the restrictions set by the KSA investment authorities to a small “negative list” of activities closed to foreign investors could be helpful. 42 References: Aitken, B. and A. Harrison, ‘Do Domestic Firms Benefit from Direct Foreign Investment’ American Economic Review, (1999). , G. Hanson, and A. Harrison, ‘Foreign Investment, Export Behavior and Spillovers’ Journal of International Economics, 43(1997)103-32. Barro, R. and X. Sala-i-Martin, “Economic Growth” McGraw-Hill, Cambridge. 1995. Bashir, G. ‘Competitiveness of Saudi Industries: Manufacturing Costs and Productivity’ Economic Bulletin 26, Saudi Industrial Development Fund. 1997. Blomstrom, M, R. E. Lipsey and M. Zejan, ‘Is Foreign Investment the Key to Economic Growth?’ The Quarterly Journal of Economics 111(1996)269-76. Borensztein, E., J. De Gregorio and J-W. Lee, ‘How does Foreign Direct Investment Affect Economic Growth ?’ Journal of International Economics 45(1998)115-35. Chein-Hsun, Chen, ‘Regional Determinants of Foreign Direct Investment in Mainland China’ Journal of Economics 23,2(1996). De Mello, L. R. ‘Foreign Direct Investment in Developing Countries and Growth: A Selective Survey’ Journal of Development Studies 34,1(1997)1-34. ‘Foreign Direct Investment-led Growth: Evidence from Time Series and Panel Data’ Oxford Economic Papers 51(1999)133-51. Dunning, J. H. “Multinational Enterprises and the Global Economy” AddisonWesley, Reading. 1993. Ericsson, J. and M. Irandoust, ‘On the Causality Between Foreign Direct Investment and Output: A Comparative Study’ The International Trade Journal, 15,1(2001)1-26. ESCWA, ‘Statistical Abstract of the ESCWA Region’, United Nations, 2000. Faddli, A. M. Model of Foreign Investment in Saudi Manufacturing Industry. Unpublished M. Sc. Dissertation. King Saud University, Riyadh 2001. Grossman, G. M. and E. Helpman, “Innovation and Growth in the Global Economy” MIT Press, Cambridge, MA. 1991. http://www.us-saudi-business.org/economy.htm http://www.eia.doe.gov Inter-Arab Investment Guarantee Corporation, “FDI Incentives in Arab Countries”, 1997. International Finance Corporation, “Foreign Direct Investment: Lessons of Experience”, International Finance Corporation, 1997. 43 Karras, G. ‘The Optimal Government Size: Further International Evidence on the Productivity of Government Services’ Economic Inquiry, 34(1996)193-203. Khemani, R. ‘Fostering Diversification and Competitiveness: Strategies and Options for the Kingdom of Saudi Arabia’, paper presented at the symposium on the Future Vision for the Saudi Economy. Riyadh 2001. Kokko, A. ‘Productivity Spillovers from Competition Between Local Firms and Foreign Affiliates’ Journal of International Development 8(1996)517-30. Markusen, J. R. and A. J. Venables, ‘Foreign Direct Investment as a Catalyst for Industrial Development’ European Economic Review 43(1999)335-56. Ministry of Industry and Electricity, Statistical Bulletin. Riyadh. 2000. Ministry of Planning, “Achievements of the Development Plans’, Kingdom of Saudi Arabia, various issues. “Foreign Trade Statistics” Central Department of Statistics. Riyadh, various issues. - ‘The Seventh Development Plan’ Riyadh, Kingdom of Saudi Arabia. 2001. - http://www.planning.gov.sa National Center for Economic and Financial Information, Annual Report. 2000. Odedokun, M. O. ‘Relative Effects of Public Versus Private Investment Spending on Economic Efficiency and Growth in Developing Countries’ Applied Economics, 29(1997)1325-36. Pfaffermay, M. ‘Foreign Direct Investment and Exports: A Time Series Approach’ Applied Economics 26(1994)337-51. Political Risk Services (PRS), Inter-Country Risk Guide’. 2000. Sanford, D. M. and H. Dong, ‘Investment in Familiar Territory: Tourism and Foreign Direct Investment’ Tourism Economics, 6,3(2000)205-219. UNCTAD, ‘Diversification in Commodity-dependent Countries: The Role of Governments, Enterprises and Institutions’ Report by Commission on Trade in Goods and Services and Commodities. 1997. ‘Foreign Direct Investment and the Challenge of Development’ World Investment Report. United Nations. 1999. van Loo, F. ‘The Effects of Foreign Direct Investment on Investment in Canada’ Review of Economics and Statistics (1977)474-81. Wang, Z. Q. and N. Swain, ‘The Determinants of Foreign Direct Investment in Transforming Economies: Empirical Evidence for Hungary and China’ Weltwirtschaftliches Archiv 132,2(1995)359-82. 44 World Travel and Tourism Council (2001), http://www.wttc.org. World Tourism Organization (2001), http://www.world-tourism.org