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9. The Importance of the GCC for the Wider Region

Author(s):
Raphael Espinoza, Ghada Fayad, and Ananthakrishnan Prasad
Published Date:
November 2013
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9.1 Economic Openness and Spillovers

The book thus far has analyzed the GCC macroeconomic stabilization and longer-term structural challenges. The importance of researching the GCC countries however is not only limited to a deeper understanding of the region itself since there are significant implications for developments in the GCC on the wider MENA region, as well as on many countries in South Asia. The GCC region is very open and extensively connected internationally. We conclude the book by discussing the economic relationships of the GCC with the rest of the world.

For decades, the GCC region has been a stable source of sizeable private as well as public foreign-exchange flows to neighboring countries. While the many expatriate workers hosted in the Gulf have steadily repatriated a significant portion of their earnings to their home countries, the GCC countries have used their natural resource windfalls to provide foreign aid as well as directly invest in a large number of countries and, to a lesser extent, to support their exports. As a result, growth linkages between the GCC countries and the wider MENA region are significant. The global crisis has indeed shown the importance of the GCC as a stabilizing economy in the region: high and resilient levels of financial flows have helped mitigate the impact of the global crisis on many countries since 2008.

This conclusion goes into the details of the spillover channels, summarizing the literature on the complementarity between migration, trade, and FDI and discussing the data and the determinants of international linkages between the GCC countries and the MENA region. Although financial flows from the GCC to its neighbors have been relatively stable during the recent crisis, the literature as well as the historical GCC data show that economic conditions in source countries matter for the volumes of the different financial flows (remittances, trade, FDI, and foreign aid) to recipients. These results confirm the importance given to economic developments in the GCC for the MENA region. The panel regressions presented at the end of this chapter show that growth in the GCC is indeed a very significant explanatory variable for growth in MENA.

9.1.1 The Importance of Migration and Remittances

The large numbers of migrant workers in the GCC is probably one of the main reasons why the GCC region is such an important source of foreign exchange flows for neighboring and South Asian countries. According to the World Bank Bilateral Matrix, the 2010 stock of immigrants from neighboring Arab and South Asian countries in the GCC constituted for most GCC countries over 90 percent of their total number of immigrants. Looking at the source countries, large shares of their emigrants are in the GCC: 84 percent of Yemeni emigrants are in the GCC, and the share remains above 40 percent for Egypt, Sri Lanka, India, and Pakistan, and over 25 percent for Syria, Jordan, and Sudan.

Reflecting the pattern of migrants, remittances from the GCC are an important source of income for many Arab and South Asian countries, and constituted, based on the World Bank bilateral remittances data, a large share of total remittance receipts in these countries. Accounting for about half of total GCC remittance outflows in 2010, India was the largest single recipient, but given the size of India’s economy these flows represented just 1.4 percent of its GDP. Remittances from the GCC constituted about 80 percent of total remittance receipts in Yemen and over a quarter of remittance receipts in a large number of neighboring Arab and Asian countries. Looking at individual GCC countries, the largest source of remittances for Yemen was Saudi Arabia, whereas the largest source for Syria was Kuwait and the largest source for India was the UAE. (Figure 9.1).

Figure 9.1.Remittances from the GCC in 2010

Source: World Bank

The resilience of remittance outflows from the GCC to the global crisis during 2008–10 is worth noting. While total world remittance outflows experienced their first ever recorded decrease between 2008 and 2009, contracting at about 7 percent (compared to 14 percent growth between 2007 and 2008), GCC outflows continued their strong, though lower, growth in 2008–9 at 13 percent, compared to 22 percent in 2007–8. A similar pattern emerges when looking at total world remittance inflows. Remittance inflows to countries that are known to receive most of their flows from the GCC (such as in Figure 9.1) continued to grow, albeit at smaller rates, between 2008 and 2009, when remittance inflows to the rest of the world contracted for the first time ever. This indeed reflects the resilience of GCC economies’ growth rates to global distress.

9.1.2 International Trade

A well-established literature has shown the role of migrants, especially skilled ones, in contract enforcement and information transmission needed to develop international trade between home and host countries. Using a panel dataset of bilateral trade between the US and forty-seven trading partners from 1970 to 1986, Gould (1994) found a strong positive effect of immigrant networks on US exports to, as well as imports from, immigrants’ home countries. Similarly, Head and Ries (1998) estimated an extended trade gravity model using bilateral trade data between Canada, a main immigration destination, and 136 trading partners, and found, among other things, that a 10 percent increase in immigrants is associated with a 3 percent increase in Canadian imports from immigrants’ home countries, and that these effects are larger for more independent (skilled) migrants. Rauch and Trinidad (2002) do not focus on a specific immigration destination but instead show the large effect of ethnic Chinese business networks on global bilateral trade patterns.

Although trade with the MENA region has represented only a small share of total GCC imports and exports (only 3 percent of GCC imports originated from non-GCC MENA countries, Figure 9.2), for many countries, trade with the GCC has been the highest relative to the size of their economies. In line with the gravity models of international trade, bilateral trade data show that the countries where trade with the GCC represents the largest share of their own exports and imports tend to be within close geographical proximity. However, the migrant networks also matter. Countries where the GCC accounts for more than 15 percent of outgoing exports are Jordan, India, Lebanon, and Syria, and more than 10 percent Yemen, Egypt, and Pakistan. Imports from the GCC into neighboring countries are also significant but they mainly comprise oil (Figure 9.3).

Figure 9.2.Geographical distribution of GCC merchandise trade, 2000–10

Note: Advanced Asia includes Japan, Republic of Korea, Hong Kong, Singapore, Taiwan

Source: IMF Direction of Trade Statistics

Figure 9.3.Merchandise trade with the GCC, 2011

Source: IMF Direction of Trade Statistics

9.1.3 Complementarity between Migration and FDI1

Large migrant networks can also bring in foreign capital to the labor-exporting economies. This hypothesis of complementarity between migration flows and FDI flows, however, challenges the standard trade substitutability effect, which argues for a negative relationship between labor outflows and capital inflows (since the former increases the relative return of labor and therefore decreases the attractiveness of the domestic economy to foreign investors).

The complementarity hypothesis is that the presence of an educated diaspora provides foreign investors with a much-needed knowledge of the domestic consumer and of the local labor and input markets (including consumer preferences, regulations, etc.). This helps break contractual and informational barriers to long-term inward foreign investments in the labor-exporting country. In addition to the resulting financial remittance transfers from overseas professionals, skilled emigration can thus lead to improved development in labor-exporting countries, and in this particular setting, the argument is that educated migrants either attract foreign investors or themselves make investments in their native countries. Unskilled migrants can also increase FDI by revealing workforce characteristics (such as worker productivity) and decreasing cross-border information costs, thereby reducing uncertainty about the profitability of FDI. Furthermore, migration could also provide unskilled migrants with the necessary human and physical capital to invest in their home countries, an opportunity that would not be possible without migration. In the MENA region specifically, the migration channel can be one of the main drivers of FDI for a set of countries with highly skilled emigrants but where political and macroeconomic instability is a deterrent to FDI.

The empirical evidence has been in favor of the prevalence of the complementarity effect. Taking into account the potential endogeneity between migration and FDI, Javorcik, Ozden, Spatareanu, and Neagu (2011) find that the presence of migrants from fifty-six countries in the US encouraged US FDI flows into those countries, with a stronger effect for skilled (educated) migrants. Kugler and Rapoport (2007) show the existence of contemporaneous substitutability and dynamic complementarity between migration and FDI, with a stronger relationship for migrants with highest schooling attainments. In the short run, the trade substitutability effect prevails as increased immigration and the resulting factor price changes reduce the incentives for FDI. In the long run however, the migrant network effect comes into play and dictates a positive relationship between (mainly skilled) emigration and positive future FDI. Kugler and Rapoport (2007) argue that the migration-FDI effect can be interpreted as a reduction in the domestic economy risk premium required on foreign investments. Gao (2003), Federici and Giannetti (2010), and Ivlevs and de Melo (2008), among others, also find empirical evidence in support of a positive association between emigration from developing countries and FDI.

The GCC region has been a major source of FDI in the MENA (over the period 1985–2009, the UAE was by far the largest investor in the region). However, intra-GCC FDI constitutes about 91 percent of total FDI outflows in Bahrain and about 61 percent in Kuwait. On the other hand, Oman has predominantly invested in Algeria, while Saudi Arabia’s investment destinations have been more diversified across all countries in the region.

For the recipient countries, GCC FDI constitutes the lion’s share of their total inward Arab FDI (over 80 percent in many cases). For countries like Jordan, Lebanon, and Sudan, GCC FDI inflows amounted to more than 1 percent of their GDP. It is worth noting that the geographical distribution as well as amount of outward FDI from the GCC to Arab countries has fluctuated over the years. For instance, Saudi outward FDI to Arab countries in both 2009 and 2010 was about a third of its value in 2006. While Lebanon received about 16 percent of total Saudi FDI to Arab countries in 2005, its share rose to about 88 percent in 2007. Similarly, Yemen’s share dropped from 31 percent in 2006 to about 0 percent in 2009. Steady recipients have been Sudan, Syria, Egypt, and Jordan (Figure 9.4). Overall, the correlation between the 2010 stock of GCC migrant workers from Lebanon, Syria, Jordan, Egypt, Sudan, and Yemen and the cumulative value of FDI invested by the GCC in these countries over 1985–2009 was 0.90, confirming the complementarity channel.

Figure 9.4.GCC outward FDI, 1985–2009

Source: The Arab Investment & Export Credit Guarantee Corporation

9.1.4 Foreign Aid

Throughout the last three decades, the GCC countries have provided large amounts of foreign aid to many countries around the globe, with Saudi Arabia being the top Arab aid donor, followed by Kuwait, the UAE, and more recently Qatar.2 Arab aid is mostly exogenous to recipient countries’ economic conditions, as it is mainly driven by oil export revenues, hence inheriting the volatility of oil prices (Figure 9.5). Thus, Arab aid is positively correlated to the economic situation in the donor countries, a situation that mimics what has been found in the aid flow literature (e.g., Pallage and Robe 2001).

Figure 9.5.GCC aid outflows by source country, 2002–10

Source: Arab Monetary Fund

Arab aid is characterized as unconditional and highly concessional with low interest payments and long repayment and grace periods, and emphasizes the importance of ownership of recipient governments of aid-financed development strategies and modalities of implementation. There are two major modalities of Arab aid: direct bilateral aid extended by Arab governments and aid granted through development funds (national and regional). In addition, Arab donors contribute to major international donor agencies and through charitable institutions. GCC bilateral assistance is mainly unconditional and grant-based. Even when involving loans, low interest rates and long repayment periods mean that the grant element is generally over 80 percent, compared to 40 to 45 percent for aid provided through the development funds. Bilaterally, the GCC have donated since 1970 a cumulative amount of $147 billion, constituting 95 percent of total Arab aid.3 Saudi Arabia has ranked as the top donor by far. Contributing about 1 percent of its GDP over the past decade, Saudi Arabia has provided over $100 billion in bilateral foreign assistance since 1970, about 68 percent of total Arab aid. Kuwait has provided about 14 percent, followed by the UAE (9 percent) and Qatar (3 percent).

Since 1962 Arab development funds have provided about $104 billion in aid, mostly through regional, rather than national, development funds. For instance, Saudi Arabia contributed only about 10 percent of the total through its development fund, but has also made direct contributions to the regional funds (Figure 9.6). The bulk of this aid has been directed to Arab countries (61 percent), followed by Asian (22 percent), and African countries (15 percent). This aid has mostly been aimed at project financing, with transport, communication, and energy being the main sectors (Figure 9.7), and with an increasing focus on the private sector over the past decade. In addition to traditional transfer modalities such as concessional loans and grants, this category of assistance also operates through guarantees, technical assistance, and training.

Figure 9.6.Arab aid through development funds, 2002–10

Source: Arab Monetary Fund

Figure 9.7.Sectoral distribution of Arab aid through development funds, 2002–10

Source: Arab Monetary Fund

9.2 Concluding on the Importance of the GCC

We conclude by estimating a growth spillover model that sheds light on the quantitative importance of GCC growth for economic developments in the neighboring MENA countries, given the spillover channels described earlier. The data is based on a panel model for sixteen countries of the MENA region,4 for the period 1995–2008. The model is a fixed-effect model5 with real GDP growth in MENA countries as a dependent variable (non-oil GDP growth for the oil producers). The independent variables are the average of non-oil GDP growth in the GCC, average G7 growth, Japan’s growth (to capture the Asian crisis), oil prices, world trade growth, the Fed Funds Rate, and the VIX index. In addition, the lagged depended variable was also included, but it was not found to be significant.

A general-to-specific approach shows that growth in the GCC is the most significant variable explaining growth in the other MENA countries (see Table 9.1). The growth elasticity is around 0.4–0.5 and was found to be robust to the inclusion of control variables and to the use of pooled OLS, random effects, or fixed effects. Surprisingly, G7 growth and oil prices were not found to be significant and the coefficient for world growth was negative. The results are consistent with the findings of Ilahi and Shendy (2008), who also investigate the importance of remittances and financial flows and transmission channels.

Table 9.1.Growth spillover model
(1)(2)(3)(4)(5)(6)(7)
FEFEFEFEFEFEOLS
VARIABLES
Real GDP growth in individual MENA country (t-1)−0.0337−0.0337
[-0.348][-0.349]
G7 real GDP growth−0.0277
[-0.0423]
GCC real GDP growth0.556***0.558***0.477***0.469***0.300**0.349***0.415***
[3.152][3.608][3.070][3.041][2.318][4.025][4.563]
Japan real GDP growth−0.240−0.238−0.170
[-0.733][-0.747][-0.523]
Oil price percentage change0.0306**0.0306**0.0239*0.0212*0.008230.008650.0105
[2.390][2.398][1.857][1.942][0.877][0.910][1.056]
World trade growth−0.291−0.297*−0.232−0.256*
[-1.175][-1.770][-1.398][-1.742]
Fed Funds Rate0.00377*0.00373*0.002030.00206−0.00101
[1.861][1.777][0.880][0.904][-0.616]
VIX index−0.00100−0.00100*−0.000973*−0.000792−0.000534−0.000380−0.000363
[-1.639][-1.670][-1.668][-1.637][-1.120][-0.935][-0.943]
Constant0.0696**0.0693**0.0850***0.0818***0.0877***0.0770***0.0217*
[2.008][2.154][2.841][2.790][2.957][3.472][1.653]
Observations202202205205205205205
R-squared0.2480.2480.2710.2700.2540.2530.117
Robust t-statistics in brackets*** p < 0.01, ** p < 0.05, * p < 0.1
Robust t-statistics in brackets*** p < 0.01, ** p < 0.05, * p < 0.1

The growing importance of the GCC countries, especially for the MENA region, has not been fully reflected in the number of comprehensive and quantitative analyses of these countries, despite the increasing availability of data. This book contributes to filling this gap. We have combined econometric analysis and theoretical modeling with anecdotal evidence and extensive data gathering, and hope that the findings will be useful to both academics and policy-oriented practitioners interested in a better understanding of the macroeconomics of the Gulf States.

With abundant resource wealth, pegged exchange rates, fiscal policy that is mostly discretionary, and pervasive subsidies, the macroeconomic experiences of GCC countries are indeed also worth analyzing because their successes as well as weaknesses offer many important lessons to countries around the world sharing one or more of these characteristics. Chapters 2 through 8 have covered these issues, looking at both long-term structural challenges and at short-term macroeconomic management. This concluding chapter showed that the importance of the GCC economies has increasingly spanned across their borders, as they have become increasingly interlinked with their Asian, Arab and non-Arab, neighbors through aid, trade, remittances, and FDI.

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1This section only focuses on FDI outflows within the GCC and from the GCC to its Arab neighbors, where the relationship is most important and comparable data available. Data are based on several issues of the Investment Climate in Arab Countries Report, which is published annually by the Arab Investment & Export Credit Guarantee Corporation. This is not say that GCC countries’ outward FDI is only focused on Arab countries. For instance, according to data by the Central Bank of Pakistan, about 17 percent of total inward FDI in 2010–2011 originated from the GCC (the UAE in particular).
2Based on several issues of the Joint Arab Economic Report, an annual Arabic publication of the Arab Monetary Fund, which provides a chapter on “Developmental Arab Aid.”
3Other Arab donors included Libya, Iraq, and Algeria.
4Afghanistan, Algeria, Djibouti, Egypt, Iran, Iraq, Jordan, Lebanon, Libya, Mauritania, Morocco, Pakistan, Sudan, Syrian Arab Republic, Tunisia, Yemen.
5The Breusch-Pagan test rejects at 90 percent the use of pooled OLS.

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