Chapter 2. The Riddle of Diversification

Reda Cherif, Fuad Hasanov, and Min Zhu
Published Date:
April 2016
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Clement M. Henry

As Reda Cherif and Fuad Hasanov conclude in Chapter 1, petro-states face daunting challenges—really a riddle for policymakers—to assure sustainable and diversified economies. Late-late developers1 must climb ever steeper quality ladders to generate sophisticated and competitive exports. Mere import substitution will not do if diversification is to be sustained. Within the Middle East and North Africa (MENA) region, the Gulf Cooperation Council (GCC) could lead the way, possibly inspired by the successes of Korea, Malaysia, and Singapore—as subsequent chapters discuss. This chapter examines the successes and failures to date of some of the oil-rich states of the region, but it is necessary first to examine the possible criteria of success. Why bother at all to diversify?

If the principal yardstick is income per capita, diversified economies usually do better than undiversified ones in the long term. On the shorter horizons of policymakers, however, the priority is political survival rather than potentially destabilizing economic reform. Within the MENA region, moreover, there are significant differences in oil and gas revenues and their contributions to national budgets. Looming budgetary squeezes are more likely to concentrate policy minds on diversification than long-term prospects. In 2013, IMF and GCC policymakers could share concerns about future fiscal balances as state expenditures rose and oil prices were not keeping up with the fiscal breakeven prices of a number of other petro-states (IMF 2013). Fiscal concerns may drive some efforts to diversify hydrocarbon-based economies, even in GCC countries where (with the exception of Bahrain and Oman) ratios of natural gas and oil reserves to production promise many decades of healthy revenue. The volatility of oil prices may concern policymakers in Kuwait, Qatar, and the United Arab Emirates, countries enjoying extraordinarily high rents per capita (Table 2.1).2 However, an abundance of capital may tempt some of them to diversify their sources of revenue through sovereign wealth funds rather than by generating dynamic export-driven private sectors.

Table 2.1Oil and Gas Revenues
CountryRents per Capita, 2009 (Dollars)Rents per Capita, 2012 (Dollars)Rents per Citizen, 2012 (Dollars)Rents, Percent of GDP, 2012Rents, Percent of Government Revenue, 2012
United Arab Emirates14,1009,93886,6202489
Saudi Arabia7,80012,89618,8575090
Russian Federation2,0802,4691930%
United States73042115%
Sources: Ross (2012); World Bank, World Development Indicators; IMF (2013, 12); and IMF Article IV consultation reports.

58 percent in 2011 before loss of Southern Sudan.

Sources: Ross (2012); World Bank, World Development Indicators; IMF (2013, 12); and IMF Article IV consultation reports.

58 percent in 2011 before loss of Southern Sudan.

Even when the very wealthy smaller states diversify their economies, their initiatives resemble overseas portfolio investment in that the new economic activities are largely in the hands of expatriate management and labor. In Qatar, for instance, nationals comprise only 5 percent of the labor force, and almost all of them are government employees (Chapter 1). In Kuwait, national participation in the labor force is greater, at 18 percent, but more than three-quarters of it is in government, and a mere 5 percent of employees in the private sector, despite official carrots and sticks. The government offers private firms subsidies to hire more Kuwaitis and requires that they meet quotas to be eligible for government contracts (for instance, that at least 10 percent of the engineers in a consultant firm be nationals). Nevertheless, most Kuwaitis, including engineers and architects, prefer less demanding jobs at higher salaries in government service. Data are not available for the United Arab Emirates, but Dubai’s spectacular diversification into a variety of international service industries also obviously depends heavily on expatriates.

Portfolio diversification, whether accomplished through sovereign wealth funds or on the ground, can hardly be rated a success—at least not in the larger oil-exporting states—unless it achieves gainful employment for the local citizenry. Sustainable employment, expanding to accommodate the surge in youth numbers, is surely the most politically significant yardstick by which to evaluate experiences of diversification in most of the MENA region. Oil wealth carries additional burdens. Being capital intensive, the industry directly employs few people, even if, as in the national oil company, Saudi Aramco, it has replaced most foreign staff with locals.

Moreover, the oil and gas industries lie on the periphery of densely interrelated product spaces (Abdon and Felipe 2006; Hausmann and others 2008; Hausmann and Hidalgo 2010). Hydrocarbons have few direct spillovers into other industrial or manufacturing sectors. Unlike textiles, say, they do not develop capacities that are readily transferrable to the production of other tradable exports. Oil-exporting countries may have less promising prospects for sustainable development than ones with fewer resources, given that “a sustainable growth model requires a diversified tradable sector” (Chapter 1). The further requirement not only of export sophistication, but also of full participation of the national workforce poses almost insurmountable problems. Any serious response to the riddle of diversification for oil-exporting economies must meet the requirements for human capital.

In examining partial successes and failures to date, this chapter seeks to define the mix of policies that might foster sustainable diversification of the MENA region’s hydrocarbon-based economies. No state in the region has developed the human capital and skills needed to generate “sophisticated” exports. Some of the smaller GCC countries have begun to invest in human capital to engage more citizens in their development strategies. The two most populous Arab oil states, Algeria and Saudi Arabia, for example, each took human and financial capital into account to break dependence on hydrocarbon revenues. Both highlight the issue of human capital formation in the context of late-late development, as the quality ladder to be globally competitive becomes an ever steeper climb.

Algeria’s Industrialization and Lost Opportunities

Algeria’s experience in the 1960s and 1970s deserves attention as the first Arab country to fully nationalize its oil industry, in 1971, ahead of Iraq and other Gulf states. It tried to translate its revolutionary legacy—as the only country in the region to wage a successful full-scale war of liberation against the colonial power—into an industrial revolution. Algeria had a total vision of rapid development and diversification: the newly discovered oil would provide the capital to develop its gas fields and then liquefy the gas, using technologies that were relatively new in the 1970s for transport to Europe and beyond. Hydrocarbon income would be reinvested in petrochemicals, iron and steel, and cement factories. These were what French development economist Gérard Destanne de Bernis (1963, 1966) called “industrializing industry,” giving rise to other industries, or planned industrialization from above. But in the words of its chief architect, Belaid Abdesselam:

The Algerian strategy of industrialization was exclusively conceived and elaborated by the authorities of the Algerian Revolution. In no way did its choices and ultimate goals derive from external sources … contrary to ideas deliberately propagated by the foreign media, particularly in France … Destanne de Bernis had no role in the definition of this conception. The goal of industrialization policy was to enable Algeria to insure by itself the largest possible assortment of inputs into its economy and the needs of its population … Our industries were to result to the greatest possible degree in inputs in basic and semi-finished products through inter-industrial exchanges operating in our national territory. (Abdesselam 2007, 1–2)

This 1960s’ “Development Decade” vision of revolutionary self-sufficiency or autarchy is easy to criticize in retrospect, after half a century of growing interdependence connoted by globalization. Algeria’s vision offered no room for tradable exports, because the revolutionaries had little interest or experience in international marketing. Moreover, heavy industrialization was capital, not labor, intensive. Other countries, such as Egypt and Tunisia, had embarked on similar schemes of import substitution by industrialization from above but could not afford to sustain their plans. They terminated their experiences in 1966 and 1969, respectively, once they had nationalized many privately held assets, for the most part foreign, and were running out of foreign exchange. Algeria’s greater oil and gas rents enabled the country to pursue its revolutionary dreams for an additional decade.

Possibly, had President Houari Boumediene not died in late 1978, Belaid Abdesselam could have pursued his strategy even longer. In 1977 he was demoted at his request from being minister of industry and energy to minister of the weakest part of his old portfolio, light industry, so as to cultivate those “inter-industrial exchanges.” He claims to have enjoyed Boumediene’s continued support and to have been one of the few ministers expected to remain in top decision-making circles after the president reconsolidated his power in a Front de Libération Nationale Congress planned for 1979 (Bennoune and El-Kenz 1990).

Boumediene’s death of a rare disease put an end to these plans and enabled Abdesselam’s many political opponents to reverse his industrial policies—in fact to “assassinate industry,” as Mohammed Liassine, his close colleague and successor as minister of heavy industry, asserted at an academic conference in 1990 (Moore 1994, 25).

Ironically, the about-turn in economic policy occurred just as oil and gas revenues were rising. And when they fell, Abdesselam’s liquefied natural gas contract with the United States’ El Paso Company would have offset them with annual revenues of $2–$3 billion had Abdesselam’s opponents not abrogated the contract (Abdesselam 1990, 293). Algeria under President Chadli Bendjedid instead went on a consumer spending spree, helped by an overvalued foreign exchange rate that resulted in a major debt crisis and, by 1987, shortages of basic products, inadequate maintenance of new industrial fixed assets, and steady declines in manufacturing value added. By 2007, Algeria was producing no more manufactured goods than Tunisia, a country with less than one-third of its population (Figure 2.1).

Figure 2.1Manufacturing Value Added in Algeria, Morocco, and Tunisia 1965–2007

(Constant 2000 U.S. dollars)

Source: World Bank, World Development Indicators.

Although it is easy to criticize Algeria’s vision of autarchic development, its shortcomings may sharpen our understanding of the challenges ahead there and elsewhere in the MENA region. Algeria was an outlier in human capital. For purposes of industrialization or even agriculture (dominated by French proprietors and foremen) education and skill levels were virtually nil in 1960, compared, say, to Korea in the same year (Chapters 5 and 10). At the outbreak of its 1954 revolution, Algeria had only 165 physicians, 354 lawyers, 350 civil servants, 100 French army officers, and fewer than 30 engineers (Malek 2010, 206). By independence in 1962 student leaders could boast that the revolution had already produced more university graduates than during the previous 124 years of colonial rule (Pervillé 2004, 30, 136).

Nevertheless, Algeria still had far fewer educated cadres than its much smaller neighbor, Tunisia, and direct French rule had offered them little administrative experience. Consequently the new industry came in ready-made turnkey projects, supplemented by “product-in-hand” contracts, reflecting an excessive dependence on foreign experts. With such limited supervisory capacities of so few university graduates, it was perhaps easier for Algeria to engage in a small number of major projects, such as the Hadjar (ex-Duzerville) iron and steel complex, expanding on a French plan to export pig iron, than to invest in a large number of light manufacturing projects. The complex became Algeria’s principal showcase in the 1970s, although the costs of the foreign expertise required to run it steadily increased rather than diminished as a percentage of total labor costs (El-Kenz 1985).

Acutely aware of Algeria’s shortages of managerial and technological capabilities, including skilled labor, the new public enterprises such as Sonatrach (Société Nationale pour la Recherche, la Production, le Transport, la Transformation, et la Commercialisation des Hydrocarbures) established a wide variety of technical higher institutes that were tied to their respective industries and were independent of the national education system inherited from colonial times. By the academic year 1984–85, the technical sector, originally funded by the ministry of industry rather than the ministry of higher education, had 58 percent of the resources earmarked for its teaching and research staff. The remaining 42 percent funded teaching and research staff in the traditional universities, who outnumbered the technical staff by a ratio of almost 2 to 1 (El-Kenz 1992, 232). As industrial production foundered, with most factories working well under capacity, a new problem emerged—the underutilized human capital of unemployed engineers and technicians. Research and development capabilities were neglected, and experienced Algerian cadres found employment in GCC countries and elsewhere.

Sadly, Algerian exports today are even less diversified than those of other oil exporters in the MENA region, and its tiny non-oil basket of exports is not only unsophisticated, but also as peripheral as hydrocarbons to other product spaces. In other words, the fixed assets, skilled labor, infrastructure, regulations, and the like that produce the very limited number of Algerian exports—only 184 products, compared to Saudi Arabia’s 336 (Hausmann and others 2008, 65)—are not readily transferrable to other product spaces. The revolution lost much of Algeria’s productive capability accumulated over 132 years of colonial rule with the departure of most of the settlers in the summer of 1962. Workers repossessed their farms, but then an agrarian revolution accelerated a rural exodus and decline of agricultural production under state management. Trade disputes with France resulted in the destruction of most Algerian vineyards, and only recently have efforts been made to restore them so as to exploit one of Algeria’s comparative advantages. Finally, many people trained for Algerian industry had to look for jobs elsewhere. Sharp discontinuities in the country’s economic policies still have unfortunate and unintended consequences, and skills and practices that were built up in one generation have not transferred into the next.

Yet, Algeria’s relatively small inventory of capabilities associated with peripheral product spaces may still guide new beginnings. An analysis of these capabilities in 2008, evaluating the potential for developing clusters of product spaces given existing capabilities, pointed to a variety of new products worth developing (Hausmann and others 2008). In order of priority, it identified “the most attractive nearby export opportunities for Algeria” as:

  • Meat, milk, and fishing products
  • Other agro-industrial products and chemicals
  • Steel and aluminum, metal products, and shipbuilding

Interestingly, the study disagreed with the government’s planning for petrochemical industries downstream from its core oil and gas capabilities, arguing that they were still too far removed from the upstream product spaces.

As an extreme case of colonial domination and emancipation, Algeria may be an outlier. It also puts into sharper focus some of the mistakes that were committed in its Promethean effort to diversify the economy. The state had less administrative capacity than neighboring Morocco or Tunisia, yet had substantially greater funds at its disposal. Its leadership also conflated Algerian and French entrepreneurs as enemies of the people, and faced the horror of nationalizing much private Algerian property. All the banks were nationalized (as in Nasser’s Egypt) and grouped into three large banks corresponding to foreign trade (mainly hydrocarbons), other industry and agriculture, and the service sectors (Naas 2003, 44–55).

Although private enterprise enjoyed greater respect after 1980, the statist banking legacy has stonewalled all reform efforts since 1986. Whether out of popular distrust for public institutions in general or because of Muslim objections to interest, Algerians tend to avoid banks. More than 25 percent of the broad money supply is kept at home, compared to roughly 15 percent in Egypt and Tunisia. Banks, in turn, offer little to the private sector. Traditionally serving as cash cows for state enterprises, they still tend to leave businesses to finance themselves unless they are public enterprises or have government connections. Table 2.2 compares Algeria’s distribution of credit to the private sector with other countries and comparators in the region and shows only Iraq, Sudan, Syria, and Yemen with similar profiles.

Table 2.2Bank Credit to the Private Sector, 2011
CountryMoney (M2) in Banks (Percent)Private Sector Credit to GDP (Percent)Credit (Billions of dollars)Credit per Capita (Dollars)
United Arab Emirates-59.1226.724,627
Saudi Arabia89.036.4228.98,092
Russian Federation72.048.1853.15,958
Sources: IMF, World Economic Outlook database; World Bank, World Development Indicators; and Saudi Arabian Monetary Agency, Yearly Statistics.
Sources: IMF, World Economic Outlook database; World Bank, World Development Indicators; and Saudi Arabian Monetary Agency, Yearly Statistics.

Algeria illustrates that without a dynamic private sector, any sustained effort to diversify an economy seems doomed. Yet servicing a booming private sector is clearly not sufficient, unless it is also hiring nationals. Algerian efforts to educate its labor force deserve attention. Only 1.9 percent of the population was in school in 1890 (Guerid 2007, 62), and by 1954 only 13.7 percent were literate. Formal education was almost exclusively in French, so that of the three-quarters of the tiny minority that read French, only one-third were bilingual in Arabic, while the remaining quarter, products of traditional schools, could only read Arabic (Lardjane 2007, 325).

Overly ambitious plans to Arabize the education system after independence came into conflict with Algeria’s massive undertaking to train cadres for modern industry. In the 1970s, observers pointed to a two-track system reminiscent of janissaries and ulama: French training for the captains of industry, Arabic for cultural and political figures (Gellner 1981). But Algeria’s cultural revolution conflicted with the needs of its industrial one (El-Kenz 1992): Arabization of the humanities and social sciences, including management, undermined industrial training efforts. Arabized cadres had to learn French to function on the factory floors (Madi 1994). The great cultural divide was also one of the background factors leading to civil war in the 1990s.

Although other oil producers never experienced Algeria’s cultural polarization, the Algerian experience may bear some relevance to the current clash of paradigms in the region. Algeria alerts us to the political implications of modern labor training and to the need to tailor it to meet the changing needs of economic diversification. Also worth noting is that despite the abundance of trained Algerian technicians and engineers, as well as unskilled labor, they have not developed effective linkages, either with businesses or trade unions. The government engages in massive infrastructure projects by importing labor forces, much like the GCC countries. And the research potential accumulated in the defunct industrial sector is largely ignored for lack of demand. Research and development is underfunded even by regional standards,3 and what remains of Algeria’s skilled manpower remains underemployed.

Saudi Arabia’s Incomplete Path to Diversification

In the 1970s, Saudi Arabia, enjoying record oil revenues, was as active as Algeria in promoting heavy industry to diversify its economy. Like Algeria, it engaged in ambitious economic planning and is currently implementing its ninth four-year plan. Yet unlike Algeria, the Saudis not only stayed the course, but also did so by welcoming joint ventures with traditional American corporate partners and other multinationals. Instead of investing in turnkey projects advised by American consultants, they benefited from international alliances for tapping new export markets in downstream petrochemical and other heavy industrial projects.

The Saudi Basic Industries Corporation (SABIC) is the government’s industrial arm. SABIC is a publicly traded company that is 70 percent government-owned and was founded in 1976. Though hardly dependent on support from private investors, SABIC issues annual reports, just as most of its multinational partners do, and conveys a sophisticated and friendly image to international business, quite unlike its Algerian government counterpart.

The corporation’s objectives, fueled by much greater oil revenues than Algeria, were equally radical. SABIC built the factories for Saudi Arabia’s two industrial cities, Jubail and Yanbu, from the late 1970s, and went on to build even more that required heavy investment, principally in petrochemical industries designed to take advantage of cheap petroleum feedstock. More recently, SABIC’s plan is for 27 more industrial cities (Kingdom of Saudi Arabia 2013, 119). As stated on its web page:

SABIC has pioneered a system of partnerships in our manufacturing activities that is often cited as a model for industrial progress in developing countries. This strategy is central to our business growth. To create our advanced manufacturing plants, SABIC enters into joint ventures with industry leaders from around the world. We offer a share in our resources in exchange for technology and expertise in human resources and global marketing.4

Like Algeria, SABIC also built an iron and steel complex, managed by its subsidiary, the Saudi Iron and Steel Company (Hadeed). Hadeed was founded in 1979, opened operations in 1983, and gradually expanded its initial output of 800,000 metric tons of long products to 3.3 million while adding an additional 2.2 million tons of flat products and another million tons of miscellaneous products.5 By contrast, Algeria’s El Hajdar complex, with a theoretical capacity of 2 million tons, achieved only 1 million in 2001. After El Hajdar was subsequently privatized and placed under foreign management, its production diminished to 500,000 tons in 2012. In 2013, the Algerian government regained majority control of the joint venture with ArcelorMittal by buying back 21 percent of the company for a symbolic Algerian dinar ($0.01).

The Saudi strategy ensured quality standards and international markets for its petrochemical exports. It avoided Algeria’s mistakes and succeeded in developing a slightly less concentrated basket of exports with twice as many products, albeit heavily weighed down by its gigantic petroleum sector.

In newly founded industrial cities, Saudi Arabia also implemented further downstream integration, not only exporting the petrochemicals, but also fostering light industries to use some of the inputs from SABIC’s factory complexes. Private enterprises moved in to take advantage of the excellent infrastructure provided by Bechtel and Parsons, hired respectively by the Royal Commission for Jubail and Yanbu. Figure 2.2 documents Saudi Arabia’s rapid progress in generating value added in the manufacturing sector. In constant U.S. dollars per urban inhabitant, it has reached Malaysian levels, at about $2,500, whereas the equivalent measure for Algeria has plummeted.

Figure 2.2Manufacturing Value Added per Urban Inhabitant, 1980–2011

(Constant 2005 U.S. dollars)

Source: World Bank, World Development Indicators.

Unlike Algeria, the Saudis offered a world-class, business-friendly environment. The kingdom joined the World Trade Organization in 2005, whereas Algerian negotiations began in 1989 and are still pending. The World Economic Forum placed Saudi Arabia 22 out of 148 countries in 2013, whereas Algeria lagged at 100 (World Economic Forum 2013). Table 2.3 presents the overall rankings of the MENA region’s oil-exporting countries and selected comparators, together with their respective ranks on education, business sophistication, technological readiness, and innovation potential.

Table 2.3World Economic Forum Rankings 2013–14(out of 146 countries)
CountryOverallHigher Education and TrainingTechnological ReadinessBusiness SophisticationInnovation
Saudi Arabia2048412830
Russian Federation64475910778
Source: World Economic Forum, Global Competitiveness Report.Note: UAE = United Arab Emirates.
Source: World Economic Forum, Global Competitiveness Report.Note: UAE = United Arab Emirates.

Rather than relying, like the Algerians, on state investment in light industry to flesh out linkages with its heavy industrial base, the Saudis relied on incentives to the private sector, including foreign investors. In other words, SABIC, Saudi Arabia’s functional equivalent of Algeria’s Ministry of Industry and Energy in the 1970s, wholly owned its iron and steel complex and engaged in joint ventures in the petrochemical sector, but did not become directly involved in most of the nearly 6,000 factories built since the 1970s. Moreover, the Saudi commercial banking system—originally a product of joint ventures with multinational banks—generated much more credit to the private sector as a percentage of GDP and per capita (see Table 2.2). The Saudi government provided additional cheap consumer credit to its citizens through specialized funds.

SABIC has also helped propagate a Saudi image of innovation that suggests an ability to climb that steep ladder of export prowess into the global economy. Its 2013 annual report highlights the creation of industrial research centers at home and overseas, in China, India, and Singapore as well as Europe and the United States. Much space is devoted to high-tech products, including quality Saudi steel and other inputs. King Saud University is another important initiative: the cutting-edge research of its world-class scientists can be applied directly to Saudi industry through the SABIC centers. Yet, as Zahlan (2012, 195) observes, “No Arab country has yet developed a national science and technology system in order to build a knowledge-based economy.”

The impressive Saudi initiatives still run into the same problem as smaller GCC states in their efforts to promote service sectors. Like those of Dubai or Qatar, they may be largely viewed as exercises in portfolio diversification, rather than sustainable development, because expatriates occupy so many of the critical positions, especially in research and development.

Like the Algerians, however, the Saudis have made determined efforts to train indigenous labor and build up human and industrial capital. Like the Algerians a decade earlier, the Saudis started with a very weak base. Like Algeria, too, SABIC developed parallel systems to train industrial cadres and engage in applied research. As well as investing heavily in a national university system, the government has resumed sending tens of thousands of Saudis abroad. Efforts have been made since 2001 to reform education so as to better match schooling with the skills demanded by the private sector, but in 2011 only 11.1 percent of private sector employees were Saudi. In the very top 0.8 percent, to be sure, more than 80 percent of the 65,000 administrative and business directors were Saudi in 2011, and included 5,934, an increase from 2,328 in the previous year (Saudi Arabian Monetary Agency 2013, 187) and offsetting the retirement or demotion of some 7,000 Saudi men. Saudis, however, comprised only 15 percent in the next rung of the hierarchy, the technical specialists who constituted about 5 percent of private sector workers.

It is still not clear whether Saudi education is producing more employable graduates, or whether those many thousands studying abroad will fit into the Saudi economy on their return, assuming that they return. Despite the many potential openings in rapidly expanding non-oil sectors, close to 30 percent of young Saudis were unemployed in 2006–10 (Looney 2014, 475), reflecting either inadequate training, poor motivation, or, like the Kuwaitis, a preference for government jobs, already largely in Saudi hands.

Despite excellent monetary policy and astutely planned allocation of tasks between the public and private sectors, the Saudis cannot be said to have resolved the riddle of sustainable diversification. While prudently mixing strategic capital investment with carefully crafted incentives to private business, the Saudis have not been able to engage many of their citizens in their model of development. Consequently Saudi Arabia faces risks similar to those that beset Algeria—potential polarization between a technocratic elite and the masses.

Necessary political reforms are beyond the scope of this chapter, but one possible response to public concern about economic management is to increase the transparency of government operations. No major Arab oil producer has yet voluntarily joined the Extractive Industries Transparency Initiative launched in 2002. One could argue that joining the initiative, an international nongovernment organization, is considered unnecessary for countries that do not need foreign direct investment. But joining might reinforce Saudi Arabia’s high standing, not only with the international business community, but also with its public at home.

Economic visions and sustainable strategies of diversification clearly cannot rely on trickle-down effects. They need private business involvement and support and understanding from broader segments of the workforce. The Korean experience discussed in Chapter 10 offers one illustration of how rural folk were prepared to move into the modern economy.

Thinking Outside the Box

The Saudi experience in industrial diversification may be instructive, but new initiatives will be needed to engage the citizenries of the GCC for any of their respective projects to be sustainable. The region clearly enjoys capital abundance but needs to develop the human capital to cultivate it. To date, much of the recent investment in human capital has been top-down, bringing in the foreign experts to transfer cutting-edge science and technology. Qatar and Abu Dhabi host branches of top American universities servicing their international business plans, while King Saud University picks up academic stars. Highly qualified expatriates tend to be mobile, however, and their science and technology will not acquire roots to survive their departure. Inspiration and innovation need local roots.

To be sure, the development state is needed, to build schools and universities and to send students abroad, possibly emulating the meticulous interventions of Singapore (Chapter 3). The state may also be viewed as a venture capitalist needed to nurture export sophistication and climb up the quality ladder, but the ventures are perhaps better accomplished in association with more experienced multinationals, as the Saudi model illustrates.

The state’s primary challenge is to set appropriate incentives for capital and labor. The Saudis and others compete to offer appropriate incentives for capital and “business friendliness,” but what about the workers? How, if at all, can the state make people want to work and to acquire the skills needed to be gainfully employed? What sort of environment can favor the construction, so to speak, of human capital from below?

States may, like Saudi Arabia and Algeria, generate human capital from above, but movement from below is also needed and presumably starts at a very early age. Women’s education in much of the MENA region lagged a generation behind that of Southeast Asia. Now that the mothers are literate (Figure 2.3), they may read their children story books. The content matters. As David McClelland (1961) pointed out half a century ago in The Achieving Society, stories about hard work and upward mobility may make small children higher achievers later in life. The state or some charity might sponsor contests for writers, perhaps young mothers among them, to write good stories. Poetry contests may blend Bedouin tradition with Arab legacies. Smart toys can introduce children to the robots of industrial and post-industrial society. Informal as well as formal education should inculcate values of hard work and respect for nontraditional avenues of achievement, by technicians and plumbers as well as worldly managers.

Figure 2.3Female Literacy

(Percent, aged 15–24)

Sources: UNESCO Institute for Statistics; and World Bank, World Development Indicators.

If their citizens are to participate fully in diversified economies, states must develop a work ethic in their citizens from an early age and help them to become competitive with their peers in other advanced countries. Rather than obsessive attention to portfolio diversification and imports of high-tech expertise and brand-name universities, the highest priority must be given to ground-up primary education to rectify the poor showings in mathematical proficiency and other basic skills demonstrated in Trends in International Mathematics and Science Study testing. Finland may have lessons for many countries’ primary and secondary schools, including those of the United States. Finnish schoolteachers are well respected and properly paid members of their communities—not unlike the ulama and village teachers of precolonial times in the MENA region.

Cutting-edge services need not be focused exclusively on global competition. The GCC is part of the Arab region, sharing the lofty vision of Arab cultural, educational, and economic integration articulated by the Economic and Social Commission for Western Asia of the United Nations. The GCC may enjoy a certain locational advantage from proximity to Arab Bedouin traditions with minimal disruption compared to Western intrusions into Algeria or even Egypt. That oil production enclaves were so peripheral to these Gulf societies gave them a certain historical advantage. In the much wider Dar al-Islam they lie at the center of a vibrant global civilization (Bianchi 2013). Value-added hajj tourism, staffed by faculty and students specialized in religious studies, could develop into a high-tech global service space.

Islamic finance is another key service area of great potential. Wealthy Saudis are already its driving force, cultivated today primarily by big London- and New York-based banking monoliths. The growing set of Islamic financial practices seems bound to grow, given the beliefs of millions of Muslims who avoid conventional interest-based banking. Why not encourage labor-intensive microfinance that most conventional banks shun? Experiments in Egypt show greater receptivity among villagers to a sharia-compliant procedure (interest free) than to the Grameen Bank’s method based on interest (El-Komi and Croson 2013; Ali 2012; El-Gamal and others 2014). Egypt is potentially a huge market, and public opinion in other Arab countries shows even greater distrust of conventional banking and, hence, potentially a fertile field for Islamic finance. More finance for small and medium-sized enterprises might encourage enterprises to emerge from the shadows of the informal economy and alleviate the credit shortages underlined in Table 2.2.

Table 2.4 records the responses of representative national samples in the MENA region to Arab Barometer surveys conducted in 2006–08 and in 2011 to the question of whether bank interest accords to the teachings of Islam. Large majorities in most of the countries surveyed considered interest forbidden, despite findings by some religious authorities that it was acceptable under certain conditions.

Table 2.4.Arab Attitudes toward Bank Interest
CountryCharging interest by banks contradicts teachings of Islam (Percent agreed)Banks should not be allowed to charge interest (Percent agreed)
West Bank and Gaza858669
Saudi Arabia-7774
Source: Arab Barometer I and II,
Source: Arab Barometer I and II,

A second question in the 2011 surveys was whether conventional banks should be allowed to charge interest, given the needs of the modern economy. Here opinion was more divided. Still, over half of the respondents opposed conventional banks charging interest, except among the Lebanese and Egyptians, some of whom were Christian, and the Tunisians. Sophisticated Islamic financial services might offer another tradable niche in the global economy.

There are no easy solutions to the riddle of sustainable diversification. Starting with relatively modest reserves of human capital, combining labor-intensive activities with export sophistication is a daunting challenge. Cultural services deserve greater attention as one of several approaches, and these, too, may constitute “sophisticated” exports to the 1.5 billion Muslims scattered across the globe. There is no substitute, however, for an expanding set of sophisticated, high-tech exports of goods and services. Cultural services and even import substitution possibly can be added to the mix, and planners might envision stages of human capital formation that combine strategies from above and below to escape the oil ghetto of product spaces.


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1Late-late developers are usually economies that started developing in the second half of the twentieth century, such as Korea.
2Oil rents in general are defined as the value of oil production at world prices less costs of production, which are mostly fixed costs incurred in the past.
3World Bank, World Development Indicators.

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