Information about Middle East Oriente Medio
Chapter

IV. Labor Market Challenges and Policies

Author(s):
International Monetary Fund
Published Date:
November 1997
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A. Current Policy Approach

The prospects of tighter labor market conditions have already prompted a policy response in several GCC countries to facilitate the absorption of a large number of nationals expected to enter the labor force (see Box 2).10 These policies have many common features. Most importantly, labor market policies are formulated within a broader framework of government expenditure containment and structural reforms aimed at increasing the economies’ resilience to adverse oil market developments and enhancing efficiency by creating a more conducive environment for private sector activity.11 With the recognition that in the period ahead, the responsibility for economic growth and job creation primarily rests with the private sector, policies are being defined in the GCC countries to facilitate the employment of nationals and increase labor market flexibility.

Box 1.Illustrative Labor Market Scenarios in GCC Countries. 1995-2010 1/

Illustrative scenarios based on simple labor demand and supply functions suggest tighter market conditions in the coming decade. Demand for labor would be affected by slower real GDP growth (2-3 percent a year) and moderate productivity gains. Supply of labor is projected on the basis of population growth, population age and gender profile, and small increases in labor participation rates. Net migration is assumed to be small. On this basis, the overall employment gap - defined as the ratio of the difference between supply and demand for labor to total labor force - would double to 10 percent in the first decade of the next century.

(Average annual changes in percent; employment gap in percent of labor force)

Employment opportunities for foreign labor could become more limited due to slower growth in overall employment and the labor substitution policies pursued by the GCC countries. Neverthless, the GCC countries’ reliance on foreign labor would still remain significant even if all new national entrants to the labor force find employment and foreign labor meets the residual demand.

(In millions)
1/ See appendix for details.

Chart 2.GCC Countries: Government Wages and Expatriate Remittances, 1975-95

Sources: IMF, International Finance Statistics; IMF, World Economic Outlook; and IMF staff calculations.

The policy instruments to achieve the employment objective have included measures that affect the quantity, price, and quality of labor. Measures influencing the quantity of labor include quotas and targets on employment of nationals and the regulation of the foreign labor force through administrative means. The relative prices of national and foreign labor are being influenced by government wage policy, direct wage subsidies to private sector, and fees and charges on foreign labor. At the same time, the quality of national labor is being upgraded by proper education and training. Moreover, measures are being implemented to increase market efficiency by facilitating labor mobility in the private sector.

a. Selective employment policy

In almost all GCC countries, the traditional liberal employment policy in the government sector is gradually being replaced by a more selective recruitment policy to reduce overstaffmg, which has emerged as a major problem in many government departments and organizations. Moreover, many vacancies in the government sector remain unfilled, qualifications for new recruits are being tightened, and early retirements and dismissals for inadequate performance are becoming more common. Labor shedding—always a socially sensitive issue—has also become a policy option in some countries. In Oman, as part of a broader policy, the government has launched an ambitious retrenchment program to retire some one-fourth of Omani civil servants over the 1996-98 period, and the number of expatriate civil servants was reduced by 7 percent in 1996 alone. Efforts are also being made to place expectations regarding future employment opportunities on a more realistic footing. Several GCC countries have formally announced that job openings in the public sector are likely to remain very limited and that job seekers should look toward the private sector. In Bahrain, the government has indicated that under the current plan (1996-2000), the private sector would account for 80 percent of new job creations.

Box 2.GCC Countries: Labor Market Reform Programs

Bahrain. The Bahranization program established in 1988 was the earliest formal labor market strategy launched by the GCC area to create employment opportunities for nationals The current program seeks to provide 6,000 additional jobs a year for Bahrainis by requesting firms to increase employment of nationals by 5 percent a year until one-half of their labor force are Bahrainis. At the same time, the Human Resource Development Support Program introduced in 1994 seeks to promote the employment of Bahrainis in the private sector by offering financial incentives to small- and mid-sized firms in the manufacturing sector that employs at least 30 percent Bahrainis and meet certain other criteria.

Kuwait. The Five Year Plan (1996-2000), currently under consideration by the National Assembly, targets to creation of 10,000 jobs a year for Kuwaitis during the next five years raise the share of nationals in the labor force to 25 percent. Policies to achieve these objectives include raising the cost of expatriate labor, limiting employment of nonnationals in certain businesses and activities, and upgrading the skill levels of nationals.

Oman. The current Five Year Plan (1996-2000) sets labor market policies with the aim of providing 17,400 new jobs a year and increasing the proportion of national labor in the total labor force from 36 percent to 42 percent. Moreover, National Vocational Qualification Program launched by the government in 1995, and financed taxes on expatriate workers, aims to improve the skill levels of Omani nationals.

Qatar. Unemployment is virtually nonexistent in Qatar and there is no formal labor market strategy.

Saudi Arabia. The Sixth Development Plan (1995-2000) sets to create 319,500 jobs and reduce the number of non-Saudi workers by an average of 1.5 percent a year through a combination of incentives and target, including financial support to firms committed to training nationals; minimum targets for employment of Saudis; restrictions on employment of skilled and semiskilled workers; and a national information campaign. In April 1995, all private sector establishments with more than 20 employees were required to increase their Saudi workforce by no less than 5 percent annually and to ban hiring non-Saudis in certain job categories.

United Arab Emirates. There are no formal plans covering the federation, but the Dubai Strategic Development Plan (1996-2000) aims to increase the share of nationals in the Emirate’s labor force from 7 percent to 10 percent by raising labor force participation and facilitating the employment of nationals in the private sector. The government supports vocational and technical training and chambers of commerce internship programs for nationals.

b. Wage restraint

Fiscal consolidation in several GCC countries has required exercising wage restraint in order to contain the large government wage bill. In Kuwait, wages have been frozen for some time, and wage increases awarded in 1996 to government employees in Qatar and the United Arab Emirates were the first such adjustments in many years. Although the government wage structure is being adjusted upward less frequently and more moderately, annual salary increments are being paid almost automatically and nonwage benefits and allowances have increased in some cases.

c. Quotas on employment of nationals

Quotas or targets on employment of nationals have been in existence in most GCC countries for many years, but rarely enforced until recently. In most cases, quotas specify a minimum number or ratio of nationals to be employed in private sector establishments, and in some cases eligibility for securing government contracts is linked to such a requirement. In Kuwait, private sector industrial establishments are required to have nationals representing at least 25 percent of their total employment (Industrial Law No. 6 of 1965). Consideration is also being given in Kuwait to award government contracts only to those domestic firms in which 40 percent of the labor force is composed of nationals, earning a combined salary of no less than 40 percent of the firm’s total wage bill. In Saudi Arabia, the number of nationals employed in private establishments should not be less than 75 percent of the work force and their wages not less than 51 percent of the total wage bill (Article 45 of the Labor and Workman Law of 1969). In Bahrain, new establishments employing 10 or more workers are required to have 20 percent Bahrainis in their work force. In Oman, a ministerial decree in 1994 set sectoral targets on employment of nationals for firms with more than four workers. In the United Arab Emirates, there are indicative targets on the share of nationals employed in the banking sector.

d. Regulation of foreign labor through work permits

Some GCC countries have placed limits on issuing work permits to regulate employment in certain sectors and even in some occupations. Such measures are intended to regulate the market in certain low-skill activities (e.g., construction and farming) where surplus labor has emerged; and to encourage employment of nationals in areas of higher skill (e.g., banking, insurance, legal, and other services) by keeping wages high. In Kuwait, work permits issued to foreign workers are confined to selected activities in the private sector (1994 Amendment 107 to the Labor Law). Saudi Arabia has similar sector-specific restrictions on issuing work permits. In Oman, there are annual overall and regional ceilings on the number of new foreign workers. Compliance with the terms and conditions of work permits is also being enforced more tightly in most GCC countries. In the United Arab Emirates, under a general government amnesty program, some 150,000 foreign workers without proper work authorization left the country by the end of 1996. In mid-1997, the government of Bahrain requested foreign workers without valid work permits to leave the country within a period of three months. A similar amnesty program was also announced by the Saudi Arabian government in July 1997.

e. Direct subsidies

In some GCC countries, cash benefits and wage subsidies are being offered to private sector establishments to encourage them to employ more nationals. In Bahrain, the government provides payments of up to BD 1,000 a year to midsize private manufacturing firms, which maintain 30 percent of the Bahraini workforce. In Kuwait, consideration is being given to provide social allowances from the government budget to all nationals working in the private sector in order to increase the attractiveness of private sector employment.

f. Raising the cost of foreign labor

Most GCC countries have imposed various fees and charges on expatriate workers and their families. Almost all countries have fees for issuing and renewing visas and work permits for foreign workers; in some recent cases (e.g., Saudi Arabia), these fees have been raised substantially. Kuwait has imposed a flat fee on hiring domestic servants. In Oman, the fee for issuing a work permit is set at 7 percent of the annual salary of the foreign worker and the proceeds are earmarked for training nationals. In addition to raising the cost of foreign labor, such fees and charges act to defray part of the administrative cost of processing and issuing entry visas and work permits, and have been viewed as a form of taxation of foreign labor for the use of free or highly subsidized public goods in the host countries. In some countries, the expatriate workers make nominal payments for using government health services and in the United Arab Emirates and Qatar, foreigners are subject to higher electricity and water tariff rates. Nevertheless, in all GCC countries, foreign workers continue to be exempt from income taxes and other direct taxes on the same terms as nationals.

g. Education and vocational training

All GCC countries recognize the central role of education and training in their labor replacement policies. Part of the skill deficiencies of nationals is being addressed by vocational training and by on-the-job and in-house training. In Oman, a national program on vocational training is being managed by the private sector and financed through taxes on the private sector, as mentioned earlier. Saudi Arabia’s Five-Year Development Plan sets out specific targets for general and higher education, and for technical and vocational training as a part of its human capital development objectives. In the United Arab Emirates, school curricula have been revised to focus on vocational training, and local governments and chambers of commerce are providing training and internships financed from their own resources.

h. Increasing labor mobility

In parallel with measures aimed at facilitating the absorption of nationals in the labor market, some GCC countries have taken steps to increase market efficiency by increasing the mobility of expatriate workers between jobs in the private sector. Regulations in Saudi Arabia allow transfer of sponsorships subject to certain conditions. In 1995, Oman allowed expatriate workers to move between sponsors, subject to the approval of the original sponsor, without first leaving the country as had been the requirement earlier. Similarly, in early 1997, the United Arab Emirates permitted transfer of sponsorships between employers after one year of service subject to approval of the employee as well as the new and the original sponsors. Moreover, expatriate workers in selected trades and professions in the United Arab Emirates were allowed to hold a part-time job or a full-time job with another employer for a period of up to six months.

B. Parameters of a Labor Market Strategy

Policymakers in the GCC countries recognize the importance of sustained economic growth for generating employment opportunities. Growth and development strategies are being formulated consistent with the countries’ comparative advantages and resource constraints, and policies correctly stress the role of the private sector as the principal source of employment creation in the future. Linkages between the labor market and private sector activity run in both directions: a more efficient labor market would contribute to economic growth, which would in turn support job creation. As such, broadening the role of the private sector would also need to consider policies that would involve transfer of responsibility between the private and public sectors, including those related to deregulation and privatization.

Labor market measures already adopted or being considered in the GCC countries range from market-based strategies (e.g., wage and employment restraint, increasing labor mobility) to mandatory and administrative policies (e.g., quotas on employment of nationals, market regulation through work permits). In between there is a mix of other measures (e.g., taxation of foreign labor, direct employment subsidies) intended to achieve the same objectives. An effective strategy to reduce labor market segmentation and improve market efficiency would need to consider: (1) determining wages and benefits on the basis of market conditions; (2) minimizing market distortions; (3) limiting mandatory employment policies; and (4) improving human capital. A menu of mutually consistent and reinforcing options to achieve these objectives would include the following.

Terminating the de facto or de jure policy of guaranteed government employment to nationals. A commitment to provide gainful employment opportunities for nationals, as legislated in most GCC countries, should not be interpreted as a policy of guaranteed government employment. Reducing total government employment in a phased manner through attrition, elimination of vacancies, and trimming redundant workers would send a clear signal that the government can no longer be viewed as a source of permanent employment. Over time, this would reshape the expectations of nationals, alter their educational objectives and priorities, and together with measures to reduce relative wage and benefit disparities, encourage them to seek employment in the private sector.

Reducing disparities in incentives between public and private sectors. In principle, wages in all sectors and activities should reflect market conditions and the scarcity value of the labor, and the incentives associated with allowances and benefit packages should be neutral across sectors. As nominal wage cuts are likely to prove difficult, correcting the misaligned wage structure would mean, in practice, allowing public sector wages to erode gradually in real terms over time. Moreover, in some countries, the existence of minimum wages for nationals has increased the incentive for hiring nonnationals. This disincentive could be eliminated by removing the minimum wage requirement for nationals or, as the second best solution, by extending its coverage to nonnationals.

As regards nonwage benefits, it should be feasible socially—and justifiable economically—to reduce, restructure and better target various income supplements and allowances that are being provided to public sector employees. On a broader level, the real challenge is to separate social welfare policies manifested in benefit packages from strict wage policies. A bold and far-reaching approach—though administratively difficult—would involve replacing allowances currently provided only to nationals in government employment with a smaller social cash benefit package payable to all nationals employed in the public and private sectors. This would eliminate a major incentive associated with government employment and should not burden the budget excessively at this stage, given the relatively small share of nationals working in the private sector. Moreover, direct income transfers of this nature would allow a restructuring and eventual phase out of other subsidies and transfers provided to nationals.

A major disincentive for working in the private sector could be corrected by introducing an unemployment insurance scheme and a pension system funded by contributions from employers and employees.12 Ideally, the coverage of pension benefits would need to be extended to expatriate workers in order to remove the disincentive of hiring higher-cost nationals. Other considerations would include narrowing the gap between the public and private sectors with regard to working hours, paid leave, and other related benefits.

Phasing out mandatory employment quotas for nationals. Establishing employment targets for nationals in relation to the total labor force or for specific sectors and activities would provide useful indicative guides for governments’ labor replacement policies, but mandatory quotas could be counterproductive in the long run in the absence of downward flexibility of wages. Under a quota system, employers are likely to hire nationals at lower skill and pay levels to meet the prescribed targets, thus defeating the initial purpose of providing opportunities for the national labor at higher skill levels. Quotas are also likely to be resisted by private sector employers who lose employment flexibility and may have to pay higher wages. This would contribute to underemployment of labor and by adversely impacting the firms’ competitive position would tend to undermine the authorities’ broader objective of promoting private sector activity. As a general rule, private sector employers should have sufficient flexibility to hire the most qualified labor—both national and expatriate—at market wages in order to maintain competitiveness.

Facilitating labor mobility across sectors and activities. The existing system of hiring expatriate workers under the sponsorship of nationals, which is the practice in all GCC countries, has two major shortcomings: first, it creates rent-seeking opportunities, which could be easily exploited by potential sponsors; and second, it provides no or, in some cases, only limited scope for moving between sponsors and jobs. It is also not cost effective because in most cases, labor can only be hired from abroad at a higher initial installation cost when it would be more economical to tap the existing labor pool at home. Moreover, all other things equal, potential employers are likely to hire, train, and retain expatriate workers rather than nationals who could easily move to higher paying jobs after training. Allowing expatriate labor to move between sponsors and jobs—subject to compensation for initial installation costs and other arrangements agreed between sponsors—would increase the efficiency of the labor market by channeling labor to its most productive uses.

Requiring expatriate workers to pay for government services. Imposing or raising fees and charges on expatriate labor would not, in itself, help the integration of the labor market. It also raises other issues and considerations: such fees may be absorbed by either the employer or the employee or both, and be reflected in higher final output prices and/or in reservation wages. Typically, the extent of disparity between the reservation wages of nationals and nonnationals in the GCC countries is such that higher fees and charges on expatriates could not close the gap to any significant extent without compromising the competitive position and the cost structure of the economy. Nevertheless, such fees and charges would act to internalize some of the costs associated with hiring expatriate labor. Reasonable fees and charges on expatriate labor could be justified—and indeed warranted—as partial compensation for free or heavily subsidized goods and services provided by the GCC governments to all residents, including expatriate workers. In the absence of other forms of direct taxation, the challenge is to strike the right balance between partial payments for government services and the impact of higher fees and charges on cost competitiveness of the economy.

Financial incentives to private sector employers for hiring nationals. As an inducement for hiring nationals, consideration is being given in some GCC countries to providing wage subsidies to private sector employers, typically on a declining scale to be phased out over a relatively short period of time. Such direct incentives aim to close the gap between the public and private sector wages without significantly increasing the wage cost of the employer, and to finance on-the-job training. Over time, it is argued, labor productivity gains would be matched by higher contributions from the employer toward wage payments, thus allowing a phase-out of government financial support. Direct wage subsidies may offer a strong and immediate incentive for hiring nationals—particularly if there are employment quotas in effect—but would be potentially costly and difficult to monitor. Moreover, it would not guarantee employment at the end of the subsidy period and is subject to misuse. From a practical point of view, it would probably be more efficient for the government to fund internships and on-the-job training organized and conducted by potential private sector employers without any direct linkages to salaries and employment.

Reorienting education and training programs. Labor market policies would be reinforced by efforts enhancing human capital development through proper education and training programs geared to the future job requirements of the economy. Specifically, policies should stress vocational and technical training to respond to the skill demands of the private sector, and encourage creativity and productivity at all skill levels.13 The experience of a number of dynamic and competitive economies in Asia shows that investment in education and training result in high private and social returns; invariably, highly competitive economies are supported by a cadre of trained and highly skilled workers. To be effective, national training programs require close coordination between the governments and employers in the private sector with respect to the goals, management, and financing of training (see World Bank, 1995).

Creating an information bank on job seekers. In most GCC countries, government agencies (usually ministries of labor and civil service commissions) maintain a registry of national job seekers and attempt to match them with vacancies in the government sector. The private sector typically relies on market information network to advertise its vacancies and meet its labor demand. Other government agencies (usually ministries of interior and immigration authorities) maintain information on expatriate workers on the basis of visas, work permits, and sponsors. One of the problems contributing to the segmentation of the labor market is the insufficient information flow between the different markets. As such, the availability of up-to-date and complete information on job seekers and potential employers in the public and private sectors would be an important element of an efficient labor market clearing system. A national data bank could be created with the purpose of matching national job seekers with the available positions in the private sector.

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