How Gulf countries can evolve their economies over the coming decades

Opec+ deferred the increase at their annual meeting last month, taking into account lockdowns imposed across a number of developed nations. AP

Oil-exporting countries of the Middle East have famously long been havens from taxation. Petroleum revenues have been ample to build modern infrastructure and welfare states. But times have changed. The present global economic environment and the advent of the Fourth Industrial Revolution necessitate change.

Lower oil prices, reduced production because of cuts under the Opec+ agreement, a slump in earnings from tourism and airlines as a result of the impact of the pandemic, and the need for fiscal and monetary to support local economies during the health crisis underpin the need for change. Regional oil exporters are projected to run a deficit of 11.2 per cent of GDP this year and 7.7 per cent next, according to the International Monetary Fund.

Both the International Energy and Opec forecast anaemic growth in oil demand to 2040, and a drop in Opec market share on 2019 levels that is not regained until 2030. After that, global oil demand may be approaching a peak or plateau. Unlike other producers, Gulf states will still be able to increase output because of their lower production costs, but likely at lower sales prices.

The oil exporters have long employed some taxes, of course: municipality fees on property, import tariffs, taxes on bank profits, charges on restaurant and hotel bills, levies on real estate sales, excise taxes on products such as tobacco and sugary drinks, and government fees for business licences and visas. Apart from oil and gas earnings, governments have received dividends from state firms and sovereign wealth funds and made money from selling land for development.

But taxes as such historically have been minor. For Singapore, the famously business-friendly city-state, tax in 2018 made up 13.1 per cent of GDP; in Sweden, the level is almost 28 per cent. For the oil exporters in the GCC and Iraq, this ranged from 1-3 per cent before the introduction of VAT.

The crash in oil prices in 2014 and again in early 2020, and the impact of Covid-19, has driven a search for new revenue-raising measures. Electricity, water and fuel subsidies have been removed, with the UAE linking petrol and diesel prices to market levels in August 2015. At the start of 2018, the UAE and Saudi Arabia introduced value-added tax (VAT) at a rate of 5 per cent, and Bahrain in 2019. In July, Saudi Arabia hiked its rate to 15 per cent, equal to the European Union’s minimum allowed.

But the looming fiscal crisis has impelled more drastic measures. Oman has announced not only that it will start levying VAT from next April but is planning to charge income tax on high earners in 2022. In June, leading Emirati lawyer Habib Al Mulla said that corporate tax in the Gulf was inevitable eventually. This would mark a sharp break with the Gulf’s model of very low to zero direct taxes.

The challenge is that the Middle East oil exporters are juggling four tricky balls. They have to raise government revenues, increase export earnings, boost employment, and diversify the economy beyond oil. Local economies are much more sophisticated than in the 1970s, when oil rents made up 60-70 per cent of GDP. But diversification into large-scale export-oriented opportunities requires heavy investment in new projects, and financial incentives for novel businesses and technologies, which take time to pay off.

Raising taxes, while energy prices have also gone up, makes businesses less internationally competitive. Similarly levying VAT and perhaps eventually property and income taxes reduces the attractiveness of the Gulf as a place to holiday, settle or start a business. Requirements to locate production in-country create employment and new industries, but at the risk of higher costs for government and the domestic economy, at least in the short term.

How can the regional countries square this circle? The UAE and Saudi Arabia have been active bringing outside capital into their energy industries, Adnoc raising more than $28 billion in a series of deals related to pipeline infrastructure, refining, real estate and other assets, and Riyadh $29.4bn from the initial public offering of a small stake in Saudi Aramco. Oman is considering selling 20-25 per cent of state oil firm OQ, and is restructuring its main operator Petroleum Development Oman to be able to raise loans against it. Privatisation of non-core state firms can raise funds as well as efficiency.

National oil corporations can improve efficiency further, but their production costs are already very low by global standards. Their heavy investment in downstream industries has created additional export value and dividends to government shareholders, though at the risk of greater exposure to the hydrocarbon industry. Saudi Arabia has bet heavily on expanding mining, hoping to add about 6 per cent to GDP by 2030; this seems promising, but is just one component.

New energy such as solar power and hydrogen is exciting, for instance Saudi Arabia's $5bn green hydrogen plant at Neom. They will cut domestic energy costs and help "future-proof" the economy against tightening global climate change policies.

But they will not generate large rents, unlike oil and gas exports. The Gulf could be a major producer of renewable electrons and hydrogen-derived products, but its production costs are not much lower than that of competitors in areas such as Australia, Chile or North Africa, once transport costs to markets are factored in.

The next decades will see the Gulf countries construct something more like typical global economies. New industries and exports must be fostered alongside a low but fiscally sustainable level of taxation. The region needs more openness to regional trade and a slimming of uncompetitive incumbents. Tax need not be feared, if it is paired with efficiency and dynamism.

Robin M. Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis