Gulf boom is unique economic challenge

03 April 2008
Nothing in history can act as a guide to GCC economic policy-making in 2008.

Mohsin Khan, director of the International Monetary Fund's Middle East and Central Asia Department, is well-qualified for the demanding position he now holds.

He has two bachelor's degrees (one from the London School of Economics), a master's degree from Columbia University and a doctorate.

Recognised as an economist of distinction by the world's top universities, Khan has worked at the fund in successively challenging posts for than 35 years and has been the IMF's top Middle East policy adviser since 2003.

And yet, asked at a conference in Abu Dhabi what advice he might give the GCC about how to stop inflation, Khan seemed uncertain.

Bridging the gap

Revaluation is essentially a political decision beyond the IMF remit. But cutting capital spending to slow growth might only tighten the bottlenecks in GCC economies, which he believes to be the main cause of inflation. There is a policy dilemma and no easy answer.

Some listeners were disappointed. Why does the world's top economic policy think tank, employing some of the world's cleverest people, have nothing useful to say on the topic?

The answer is that, almost 200 years after David Ricardo invented modern economic analysis, economists still don't know how economies work. Unlike engineers, they bridge the gap between facts measured by prices, production and consumption and the subjective factors that drive most human behaviour.

Economists quantify economies by counting what is consumed and produced each year and multiplying this by prices. That's science. But working out what determines prices, consumption and production is not.

No iron link

All economic thinking can be summarised in a single 12-word statement: when prices rise, consumption tends to fall and production tends to rise. The important word is 'tends'. There is an association between price and quantity, but no iron link.

Top economists are people with great intellects who see themselves as scientists. But, humbled by what has happened in the world economy since 1990, a new attitude has emerged. More are now prepared to say they don't know.

There are an infinite number of ways of making money and every economy works differently. The best that economists can do is to make comparisons with similar past experiences. That is why there is alarm: the only liquidity contraction comparable to what is happening now is the one after the 1929 Wall Street crash, which caused the Great Depression.

Pressed by Washington

But nothing in history acts as a guide to GCC economic policy-making in 2008. GCC states have accumulated more than $750bn worth of current account surpluses in the five years ending 2007 - but not because they wanted to.

This mass of money is due to the fact that the GCC is obliged to sell as much oil as the world needs, rather than what it needs. The states then have to return it smoothly to the financial system.

Pressed by Washington, at least half has gone into dollar-denominated assets, which is the main reason why Abu Dhabi and Saudi Arabia are resisting calls to abandon the dollar peg.

Dollar peg by-product

The GCC could lose $400bn by revaluing its currencies by 20 per cent against the US currency. It would make banking's 2007 losses look trifling.

Unprecedented spending on capital projects is needed to manage the two-fold task of expanding capacity to maximise the production of oil and gas and diversifying in preparation for a time when the world won't need any oil or gas.

This and low real interest rates, the by-product of the dollar peg policy, have unavoidably pushed growth well beyond the GCC's absorptive capacities.

What not to do

It is, therefore, correct to say that inflation is mainly due to bottlenecks. The underlying cause, however, is that GCC countries are compelled to sell much more oil than their economies require.

In these circumstances, it is easier to say what GCC states should not do:

  • They should not stop investing in oil and gas production capacity.

  • They should not stop diversifying their economies or building infrastructure.

  • They should not increase the cost of borrowing to punitive levels.

  • And they should not buy the argument that revaluation will stop inflation, because it won't.

Tight grip

What the GCC needs to recognise is that everything envisaged can be done, but not at the same time. There have to be priorities and co-ordinated action across the Gulf.

This suggestion is obvious. The fact that no economist is yet making it is evidence of the tight grip of free market ideology.

If there is a place where central planning has a role, it is surely in the Gulf. And it is surely now.

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