Sustaining long-run growth and Macroeconomic Stability in UAE: The Role of Structural Transformation and Diversification in Times of Falling Oil Prices
The United Arab Emirates (UAE) is one of the countries in the Arabian Peninsula, located in the Southeast part of the region, bordering Saudi Arabia and Oman. The UAE was made a federation of six emirates in December 1971, including Dubai, Abu Dhabi, Ajman, Sharjah, Umm Al-Quwain, and Fujairah (United Arab Emirates Country Brief, n.d.). Ras Al Khaimah is the seventh Emirate but joined them in 1972. The capital of the UAE is Abu Dhabi, and it is a part of the largest and wealthiest emirate. UAE is in the second place after Saudi Arabia based on the size of the economy in the Middle East. In addition, based on per capita, the UAE is one of the wealthiest nations in the region. The country’s gross domestic product (GDP) was estimated at US$339.1 billion at the end of 2015. The government should understand the role of economic diversification and structural transformation to ensure that the country maintains positive economic performance. Since oil prices have been declining, policy-makers should adopt new sources of revenue to sustain the economy.
UAE “Brief” Country Economic Background
The UAE has been experiencing economic challenges just like any other country in the world because of global financial problems. However, following the 2016 predictions by the World Bank, the state is expected to recover its economic growth, reaching 3% in 2018 (The World Bank, 2016). Investments in oil field developments are the leading factor behind the predicted recovery in the economic performance of the UAE. Investment in the oil sector is also expected to increase as the country improves its relationship with other countries, stabilizing oil prices and growing confidence and financial conditions. The country is progressing in economic diversification that protects the country from the adverse effects of fiscal challenges and improves the resilience of its economy. The government is anticipated to execute a GCC-wide value added tax (VAT) by 2018 and considers other changes such as enacting corporate tax and increasing excise taxes (The World Bank, 2016). Regardless of uncertainties such as the production of nuclear energy and the Brexit, the country is expected to continue performing well economically due to the restructuring of its economic operations.
Economic Indicators Forecast Overview
GDP /GDP per Capita
In 2016, the World Bank analysis revealed that the economy of the UAE was slowing down due to low oil prices as well as fiscal consolidation affecting the non-oil economic development. The real GDP growth was approximated at 2.3% in 2016 (The World Bank, 2016). The estimate would be a considerable decline from the pre-2014 oil shock average of 5% percent between 2010 and 2014 (The World Bank, 2016). The stringent standards affected consumer confidence and businesses, leading to slowed growth within the private sector. However, predictions reveal a non-oil growth at 2.4% in 2016 (The World Bank, 2016). A decline of 2% is expected in the Hydrocarbon GDP in 2016 from the anticipated 4.6% in 2015. Further estimates revealed a potential easing of the average rate of inflation to 3.3% in 2016 from 4.1% in 2015. Evidently, the economic performance of the country is slow.
Labor Force/Labor Force by occupation/Labor Force Participation
The UAE has a high rate of employment, but nationals have to contend with the increase in the number of expatriates due to its open-border foreign labor policy. The program has allowed private companies to employ expatriate workers at globally competitive wages. The factor has played an essential role in contributing to the economic development in the UAE (The World Bank, 2017). Nonetheless, the government implements measures to increase employment of nationals, which depends on skills development through improved education and training programs instead of mandatory standards like quotas. The country should adopt labor market reforms aimed at enhancing flexibility in recruitment and equalizing compensation in the public and private sectors.
Unemployment Rate Forecast 2016
The rate of unemployment in the UAE has been almost steady for the last five years since 2013. However, the 2016 estimates revealed an expected decline in the rate to 1.7% due to the increase of OPEC oil production prices (Focus Economics, 2018). Regardless of the decreasing momentum in the non-oil economy, significant reforms in the country are expected to bear fruit in the coming years. The restructuring efforts focus on enhancing business in the country by making it more accessible and cheaper by attracting more investors to create employment opportunities in the country. Besides, the state will emphasize skilled labor, increasing the employability of the UEA nationals. Currently, job creation remains a significant weakness of the UAE government, but necessary changes are underway to improve this area of the economy. The country expects an accelerated resilient output growth in the coming years.
Consumer Price Index Forecast 2016
The economy of the UAE slowed down in 2015, affecting the consumption rate in the country. According to the Federal Competitiveness and Statistics Authority (FCSA), economic growth dropped from 3.8% in 2015 to 3.0% in 2016 (Focus Economics, 2018). Low oil prices and fiscal austerity measures were the primary causes of the decrease in growth. The country experienced a rebound in private consumption in 2015 after a contraction in the same year (2016: +11.7% year-on-year; 2015: -13.1% year-on-year) (Focus Economics, 2018). The potential factor behind this reality is the subdued inflationary pressure that increased households’ purchasing power (The World Bank, 2016). The trend shows that the country might continue to experience a decline in the consumer price index until it suffers the actual positive effects of the current restructuring efforts.
Gross Investment/Budget/Public Debt/Income Distribution
Oil is the primary source of revenue in the country. Hence, the decline in the prices of the product has a negative impact on gross investment in the country. At the same time, the nation depends on the income to fund its national budget and expenditures. The oil revenues of -14.7% in 2016 contrasted to the 2015 figure affected the country’s budget increasing public debt and income distribution (UAE Ministry of Economy, 2016). A similar trend was expected in 2016 as the state pursued the policy of diversifying income sources and backing up the trend of transitioning to the knowledge-based economy. The prudent economic policy used in the previous year would still create control and rationalization of the levels of spending to achieve economic development. Consequently, the country will continue to experience budgetary constraints in 2016 and possibly until 2018.
Industrial Production, Electricity Production /Consumption
Despite the financial challenges in the country in 2015, industrial production increased by 2.2 % year-on-year in 2017. However, the increase was lower than experienced in 2016 (4.0 % year-on-year). The Industrial production index growth rate year-on-year in the UAE is given every month and shows changes in the industrial production in different sectors, including electricity production and consumption. The demand for electricity has been increasing in the country as part of non-oil economic growth. The UAE State of Energy Report 2015 revealed that consumers in the country use 20 to 30 kilowatt-hours of electricity every day as the economy continues to grow. In 2016, the rate of electricity production and consumption is expected to increase further by 9% (Government.ae, 2018). The economic restructuring, including a focus on non-oil economic development, is anticipated to increase the demand for alternative sources of energy.
Export /Import Volume/Exchange Rate
The volume of exportation in the country has also been negatively affected by the dipping of the country’s economy since 2015. The Central Bank’s recently released figures are revealing a decline in the level of exports in 2015. The possible factor behind the decline is as a result of strong dirham (2016: -0.6% year-on-year; 2015: -12.4% year-on-year) (Focus Economics, 2018). The decline in the volume of exports affects the exchange rate in the country, especially considering the imbalance between exports and imports (The World Bank, 2016). The country experienced an increase in imports (2016: +2.9% year-on-year; 2015: -4.6% year-on-year) (Focus Economics, 2018). Consequently, the country experienced a decline in the external sector’s net contribution to economic development. Economists anticipated a further decline in the volumes of exports due to the OPEC production cuts (The World Bank, 2016). However, positive changes could be experienced after 2018 due to the restructuring policies in the country.
Major Economic Challenges Facing Country
Diversification of the UAE economy is one of the challenges facing the UAE. The government recognizes the need to diversify its economy to become more knowledge-based, but the current such structures as overdependence on oil resources hinder the process. Diversification includes structural changes, including significant reforms in employment as well as in the role of education in economic growth (Schilir, 2013). The country should invest in productive sectors and create new knowledge and technology to achieve a highly diversified economy. Although it is possible, such changes might take time and considerable investment, and hence, delaying real economic diversification.
Falling Oil Prices and Effect on Government Budget and Sovereign Fund
The UAE has experienced a rapid decline in oil prices that started in mid-2014, which continues to exert pressure on the country’s economic activities. The nation did not expect a significant change in the prices of oil until 2018 as the supply in other countries such as Iran goes beyond the demand (Erken, 2016). Thus, the cost of the commodity will remain low at least for some more years. Since the UAE government depends on the revenue from the product, the low prices affect its ability to finance its budget and the sovereign fund.
Financing Budget Deficit in Times of Falling Oil Prices
The fall of the oil prices in the region has affected the country’s ability to meet its budget shortfall. Estimates given by the word Bank revealed that the UAE’s budget deficit would drop by approximately 4% of the GDP in 2016 (The World Bank, 2016). The challenge emanates from the overdependence in the oil resources, challenging the UAE government to consider other sources of revenue to finance its budget deficit, including income and corporate taxes, value-added tax, privatizations, and bond sales. However, the actual effects of such measures might take time, meaning that the current deficit might continue at least until after 2018.
Population, Local skilled labor, and Emiratization
The UAE population is high, but the local skilled labor is still limited, affecting the efforts by the government to increase the participation of native workers in the country’s private sector. As a result, the implementation of emiratization has faced a significant challenge due to the inadequate skills in the UAE to fully participate in the labor force (Forstenlechner, Madi, Selim, & Rutledge, 2012). The nation’s openness to foreign investment has allowed more qualified expatriates to work in the private sector at the expense of the locals. Thus, the government might have to restructure its primary, secondary, and tertiary institutions to develop the kind of skills necessary to participate in the global labor market.
The unemployment rate in the UAE continues to affect its economic performance. The rate increased to 1.7% in 2017 from 1.64% in 2016, with clear indications that the rate might continue to improve soon (Focus Economics, 2018). Unemployment places a considerable burden to the economic performance of the country since many people are unable to contribute to its growth, while they continue to consume resources provided by the public and private sectors.
Slow Economic Growth
The UAE has been experiencing slow growth in the economy since 2015. The predictions in 2016 included a 2.6% growth rate, but the actual figures in 2018 are 2.3% (Focus Economics, 2018). Evidently, the country is yet to pick up regarding its economic growth, affecting other developmental prospects. The slow growth rate is primarily due to the fiscal consolidations and the anticipated decline in oil production in 2017. The country’s overdependence in oil revenue poses a considerable challenge to its economic performance, especially amid decisions imposed by OPEC.
The slow growth rate in the UAE economy has affected other areas of the economy such as income distribution and education. The country experiences a considerably high level of income inequality, especially considering the low rate of natives’ participation in the private sector (Focus Economics, 2018). Although the country is investing in the knowledge economy by improving education in the country, the actual contribution of the diversification might take time.
Just like other countries globally, the UAE has suffered the adverse effects of inflation. The pegged exchange rate structure depends on strong economic performance as well as effective financial policies to ensure market confidence and price stability. However, the economic growth in the country has remained relatively low since 2015, affecting its level of inflation and exchange rate (Focus Economics, 2018). Hence, policy-makers in the country are challenged to create policies and programs to improve economic performance and strengthen its exchange rate.
Foreign Direct Investment
The UAE remains receptive to foreign direct investment (FDI) as one of the contributors to its economic development. After a decline between 2010 and 2013 due to the global financial crisis and instability in the region, the country has recovered FDI inflows (Sbia, Shahbaz, & Hamdi, 2014). The economic and political stability of the UAE attracts investors from unstable nations in the Middle East. While an increase in the foreign direct investment in a country is beneficial, it poses potential challenges in the labor market and outflow of economic gains to the parent countries.
The UAE government recognizes the role of physical and social infrastructure in the development of the economy. Hence, an increase in the economic activities in the country, including the use of technology in business demands improved infrastructure. The government has not maintained the pace in developing this area with the increase in business activities in the country (Al-Saadi & Abdou, 2016). Efforts are necessary to not only improve the country’s infrastructure but also secure the critical systems in the country to boost economic growth.
The Volume of Trade with China
The total exports from the UAE are $298,650,942,400. On the other hand, the country’s value of importation is $270,882,074,390 (UAE Foreign Trade in Figures, 2018). Over the last three years, China has remained the leading trading partner with the UAE with an increase in the value of bilateral trade by 15.1% to reach 52.65 billion USD in 2017. At 8.3%, China remains one of the principal trading partners with the UAE (UAE Foreign Trade in Figures, 2018). Following closely, the volume of trade between the UAE and countries in South East Asia, including India stood at Dh15.4 billion in 2016. India stands at 3.8% of the total foreign trade with the UAE, while Japan follows closely at 3.6% (UAE Foreign Trade in Figures, 2018). Although the country has positive economic relationships with the rest of the world, China, India, and Japan remain the most important trading partners.
Recommendations for Macroeconomic Policies
The UAE faces a significant economic challenge following the decline in oil prices in the region because of the overdependence on revenue from the commodity. Thus, the government should continue pursuing the structural transformation and diversification to counter the adverse effects of low oil prices in the region. The UAE government should consider other sources of non-oil revenue to finance its budget deficits, including being more open to foreign investment as a way of building the knowledge-based economy. However, the country will only benefit from the changes by developing its internal structures to develop information communication technologies and improve education to create a stronger internal labor force that will benefit from the changes. The country should also improve the internal infrastructure to accommodate the changes into a global economy. The UAE government should also form improved bilateral relationships with other countries outside the region to continue attracting investment and strengthen its exchange rate. The changes will create a stronger economy by achieving sustainable growth.
As it is evident from the analysis, the UAE is one of the strongest economies in the Middle East, in fact, second after Saudi Arabia. However, the country has faced economic challenges beginning of 2015 due to the decline in oil prices considering that it is the primary source of revenue for the country. The problems are essential lessons for the state to reform its internal structures and diversify its revenue sources to achieve sustainable economic development. The government has the potential to change the current financial setup by pursuing a knowledge-based economy supported by stronger trade and bilateral relationships with other countries outside the region. The government should also improve the internal structures and infrastructure to accommodate the changes in the global economic framework.