In the Gulf region, comprised of the members of the Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia (KSA), and the United Arab Emirates (UAE)), economic growth has been disappointing in recent years, especially since the fall in oil prices in mid-2014. Economic growth since that time has mostly been achieved through increases in employment, whereas labor productivity growth, measured as an increase in output per worker, has been negative across the board. In fact, labor productivity declined by 2 percent per year on average from 2000 to 2018. In most other regions of the world, labor productivity growth has been the major source of output growth for decades.
Negative productivity growth means that the economic potential of the Gulf region is not being realized. If productivity growth had remained flat rather than negative, economic growth in the Gulf region (everything else being equal) would have been faster than the average for emerging markets and developing countries. A recovery to positive productivity growth could accelerate economic growth in the region beyond that of major emerging markets in the next decade.
Increases in labor productivity (output per worker) are vital for sustained long-term economic growth. Productivity measures how efficient a nation uses its resources, ranging from better machines on the floor to innovative processes in services and, of course, skill improvements among its workers. Productivity is vital for sustained economic growth both at the macro level and at the firm level. For example, increases in productivity make it possible for business to lower prices while raising wages and maintaining margins.
The reason for the Gulf region’s underperformance in productivity is that growth in the region over the past two decades has mainly been achieved by adding more hours worked (mostly through low-skilled expat labor) and by investing in physical capital, including structures, without considering the quality of employment and capital, and their joint productivity effects. This strategy is not sustainable if a region or a firm wishes to remain competitive on the global stage because the reward for each additional worker or the return on each additional dollar of investment will decline unless it comes with better technology, more innovation, and better worker skills and organizational competencies.
The damage done by adding less productive jobs or growing investment while ignoring productivity is visible in most sectors throughout the Gulf economies, even in sectors that saw positive productivity growth rates in the beginning of the century such as financial services, transport and communications, utilities, and trade (which includes hotels and restaurants). Manufacturing and agriculture, which saw positive average productivity growth before 2008 have lost their productivity gains since. In construction, professional and business services, and the mining sector, labor productivity growth was negative before 2008 and has worsened since. While aggregate results differ for economies in the region, collectively, productivity growth decelerated in virtually all sectors of Gulf economies over the past decade.
Sacrificing productivity for the sake of more jobs is not sustainable because negative productivity growth rates ultimately lead to declining incomes and undermine international competitiveness.
Negative productivity growth in the Gulf region is very much related to its heavy reliance on the extraction and refining of oil and natural gas. For almost a century, the oil and gas sector (hereafter referred to as the “mining sector”) has determined the development of the economies in the region. Though highly productive because of its high capital intensity, the mining sector has relatively few linkages to other sectors in the economy, with the result that productivity in the mining sector doesn’t necessarily support that of other non-mining sectors. Furthermore, the volatility in oil prices, as exemplified by the latest declines in mid-2014 and early 2016, can have large effects on public budgets through sudden losses in revenues that interfere with the long-term, strategic policy focus required for sustained productivity growth.
Economic diversification, aimed at shifting the economy from a single income source toward multiple sources from a growing range of sectors and markets, has been an important economic policy goal of all Gulf region governments for decades. In recent years, several factors created more urgency for the Gulf economies to diversify, including:
Irrespective of the urgent need for diversification and its worthiness as a policy objective, shifting of labor and/or resources to sectors prone to weak productivity performance may have unintentionally contributed to declines in productivity at the economy-wide level. Making economic development less dependent on the natural resources industry, which is highly capital intensive and employs very few workers, will almost by definition bring down productivity levels for the aggregate economy.
Nevertheless, the severity of the productivity problem does depend on where in the economy new and expanded activities arise and how those are created. A 2008 report by The Conference Board, Growing Beyond Oil, found that during the early 2000s, economic activity in the Gulf region mainly expanded in low-productivity sectors such as construction and real estate. Less expansion occurred in advanced manufacturing or high-quality services, with the exception of the financial services. More than a decade onward, and despite a significant drop in oil and gas prices, it seems that diversification to sectors that do not enhance productivity has only intensified, leading to further degradation of productivity at the aggregate level.
Despite a significant drop in oil and gas prices, it seems that diversification to sectors that do not enhance productivity has intensified, leading to further degradation of productivity at the aggregate level.
The productivity story is a subtle one with important strategic policy implications. This study provides a detailed analysis of productivity growth within sectors and the aggregate effects on productivity resulting from shifts in employment between sectors. The following key findings emerge from our analysis of available data:
These results seem to suggest that diversification policies of the past have largely failed to address productivity growth. In this study, we argue that it is critical for diversification efforts to have a strategic focus on new and expanded activities that require highly skilled jobs and the innovation capabilities of the businesses creating those jobs—not just on job creation in general or investments imposed by government decisions. If productivity is a priority, the potential to create a virtuous cycle of innovation, stronger human capital, higher-paying jobs, increased spending power, and greater demand for more innovative products and services can be realized, leading ultimately to greater competitiveness and higher living standards for the population of the Gulf region.
Smart diversification policies create the conditions for qualitative growth and support markets in which private entities may respond to signals about which sectors to invest in and where to employ resources according to growth potential, profitability, and productivity.
Governments can pursue smart diversification policies by creating the conditions for qualitative growth and supporting markets in which private entities may respond to signals about which sectors to invest in and where to employ resources according to growth potential, profitability, and productivity. The following key elements of smart diversification policies would enhance productivity:
Diversification toward non-mining sectors with high productivity growth enhances sustainable growth While most productivity gains are being realized within individual sectors, expanding employment and production in financial services, utilities, and transport and communications would help aggregate productivity gains as productivity levels in those sectors are relatively high. These sectors, as well as manufacturing and trade, can also contribute to greater international competitiveness through their participation in global value chains.
Private sector development is positive for productivity growth The demographic dynamics in the region are such that the rising population will eventually limit the ability of the public sector to create growth opportunities, which makes the need for creating high-productivity jobs in the private sector urgent. While the private sector is still relatively small in most Gulf economies, there is ample scope for further productivity gains from privatization by providing adequate incentives to drive productivity growth through more flexible labor markets, access to foreign technology, and foreign direct investment.
Investment in intangible assets helps productivity growth in the long term To deliver greater productivity gains, a strategic, long-term focus is needed on activities that require more highly skilled jobs and the innovation capabilities of the businesses that create those jobs. Investment in intangible (or knowledge-based) assets that include digital information (software, data bases), innovative property (R&D and other new product development costs), and economic competencies (worker training, organizational practices, branding, and customer development) are important drivers of productivity growth, especially in advanced, high-value-added sectors within manufacturing and services.
Publication Prioritizing Productivity in the Gulf Region: A Path toward Sustained Growth through Smart DiversificationView Report