Download Diversification in the Kingdom of Saudi Arabia

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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.
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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
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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.
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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).
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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
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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
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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
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Achievements of the Development Plans (2000).
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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
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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
-
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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.
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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.
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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
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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]
fdi1
(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:
yt     n nt   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 nt  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
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