Labour crackdown shows mixed results in Saudi Arabia

10 July 2014

A conflicting picture is emerging of the impact of labour market reforms, with some contractors reporting huge losses, while economic growth remains strong

Uniform views on the full effect of the kingdom’s crackdown on migrant workers are frustratingly elusive. Talk to economists and the macro-level impact of the kingdom’s labour market reforms introduced last year appears muted. Construction companies, meanwhile, seeing sharp increases in labour costs, are far less sanguine.

After the employment status of expatriate workers was formalised in 2013, about 1 million foreign labourers left the country between April and November, while a further 200,000 illegal migrants were forcibly removed. But headline economic growth figures do not indicate a substantial drag on activity resulting from this evident disruption to the labour market; non-oil real GDP in the private sector grew 5.5 per cent in 2013, compared with 6 per cent the previous year. A drop of half a percentage point is not a major cause for concern,

Reported growth

In fact, the local Samba Financial Group reports that construction – the sector most directly affected by the labour curbs – saw 9 per cent growth last year, exceeding the previous year’s growth rate and approaching the 10-11 per cent last registered during the boom years of 2010-11. Activity in the manufacturing and construction sectors actually picked up in the fourth quarter of 2013, although there was some softening of cement sales that coincided with the government’s ramping up of the enforcement of foreign labour sponsorship rules.  

Many projects have stalled because of the manpower crisis. Many construction sites still look like graveyards

Saudi-based construction source

One explanation for the apparent marginal economic impact of the changes is that the activity of many illegal workers was never captured in the formal sector. For Saudi officials facing a welter of criticism from local and foreign contractors, these economic figures provide handy ammunition in dealing with anecdotal evidence that suggests a different picture on the ground.

At the micro level, however, the situation is less benign. There are reports of rising unit labour costs, as the smaller number of official migrants are now in a stronger position to negotiate higher salaries and better conditions, exploiting the lack of competition. Project delays, caused mainly by the inability to secure labour, are another burden. 

One Saudi-based source representing construction clients says the situation has been and continues to be dire for the construction industry. “Many construction projects have stalled because of the manpower crisis,” he says. “Many construction sites still look like graveyards.”

The King Abdullah Financial District in Riyadh, the largest construction project in the kingdom, is one such victim of the labour crackdown. The megaproject was originally scheduled to open in 2013, but may now struggle to open by next year. The main cause for the delay is the loss of the irregular expatriate workforce deployed at the project.

The government believes the disruption to the construction sector will prove a temporary blip

The apparent non-impact on the construction sector’s growth last year could also be attributed to failures in the country’s statistical system. As the Saudi-based source notes, if the construction activity figures are measured by new awards, such as the large new urban metro and national rail projects, rather than by progress on existing schemes, then the data would not be able to pick up the full impact of the labour market problems.

It is not as if the government has not been rigorous in enforcing the changes. In fact, the authorities have been ultra-vigilant, mounting numerous road checks in which Pakistanis and Bangladeshis are hauled onto pick-up trucks for deportation.

Construction companies are also struggling to obtain the required visa blocks to sponsor the expatriate workforce. “The labour office has been extremely stingy in approving new visa blocks, even in government contracts with government agency support,” says the source.

It would be surprising if the labour market reforms had no serious impact on construction companies’ performance. After all, the largest Saudi contractors depended on irregular labour for 90 per cent of their workforce. 

Contractor losses

Companies posting losses is one indicator of the tough new climate. Abdullah A M Al-Khodari Sons – one of the few local contractors to release financial results – reported a 96 per cent decline in operating profit to about SR1m ($267,000) in the first quarter of 2014, partly attributed to the fact that it has become more expensive to hire foreign workers. The company said its work permit costs increased by SR13.2m in the period. In the last quarter of 2013, Al-Khodari Sons reported a 28.4 per cent year-on-year increase in manpower costs. Firms have been forced to pay penalties if they are unable to fully resource their projects.

The pain is not shared equally, with sub-contractors feeling it the hardest. The most notable short-term impact from the labour shortages was that as much as 40 per cent of small construction firms were forced to suspend work in late 2013, as the pool of migrant workers dried up, according to UK consultancy Capital Economics.

A Gulf economist tells MEED that the challenges have tended to be proportionate to companies’ scale and financial firepower. “It’s the sub-contractors and smaller companies that have really struggled, as when it gets down to a bidding war for scarce labour, they have fewer resources at their disposal,” he says. “Previously, they had been able to minimise their cost exposure by relying on flexible and informal labour arrangements.” 

Mitigating damage

There are some means for companies to mitigate the labour impact. There are now 16 firms that have recruitment licences, although these are alleged to charge three times the market rate for secondment of their expatriate staff. Construction companies can also subcontract work to firms with a surplus of expatriate manpower, although this can destroy margins.

Contractor gripes are unlikely to dissuade the government from continuing with labour market reforms. Its argument is that any temporary pain is clearly worth the long-term benefit of a gainfully employed Saudi workforce and reduced joblessness.

There are some significant improvements to report. In January, the then Labour Minister Adel Fakeih announced that the number of citizens working in the private sector had doubled to 1.5 million since the introduction of the labour reforms. Fakeih’s claims are backed by an assessment from US ratings agency Standard & Poor’s, which in a June report noted that government reforms are resulting in some improvements to the highly segmented labour market. It said the latest data indicates that Saudi nationals’ share of total employment rose to 24 per cent in 2013, from 22 per cent in 2012, with 70 per cent of the growth taking place in the private sector, which now accounts for about 56 per cent of the employment of nationals.

“It is difficult to describe any law that essentially restricts the free movement of labour as ‘beneficial’,” says James Reeve, deputy chief economist at Samba. “But if the law is combined with enhanced education and training, then it has the potential to be helpful.”

A reported uptake in Saudi female employment in the construction sector – albeit mainly in back-office jobs – is another positive result of the changes. Other economic gains include the fresh support to the kingdom’s current account, with smaller expatriate remittance outflows resulting from the reduction in foreign worker numbers. And with more nationals employed in the private sector, that should also yield more riyals spent inside the country.  

But there are also hidden effects that will undercut some of these advantages. One is the ending of the practice in which some Saudi nationals provided help for migrant workers to obtain their residency visa in return for regular payments sourced from their business activities. The migrant crackdown has therefore resulted in a reduction in the incomes of some nationals. Recent indicators suggesting weakened household spending may partly reflect the trickle-down impact of the labour market reforms.

There are other costs that companies have to bear. Since 2012, the Labour Ministry has charged firms a fee of SR2,400 for each foreign worker employed above the number of locals. This is part of the Nitaqat system, introduced to promote the employment of nationals in the private sector. The impact of this system has been varied since its implementation in 2011. Although the construction sector has been hit hard by the migrant labour crackdown, the Saudisation targets for the sector, at 13-15 per cent, are lower than most other areas of the economy.

The Nitaqat system has instead focused more on areas such as financial services, where Saudisation quotas are significantly higher, at 80-90 per cent, reflecting the greater willingness of locals to work in those sectors.

Work in progress

The labour reforms remain a work in progress. Overall, they display the typical hallmarks of Saudi policymaking, says the Gulf economist. “At first, they go in all guns blazing, hoping to move things in a certain direction,” he says. “Then they recognise they won’t get 100 per cent results, but if they do get 50 per cent and some meaningful qualitative changes, then they will have at least have achieved something.”

The key question is whether the combination of migrant labour restrictions and the promotion of Saudi workers in the private sector will amount to more than a replay of the situation in the 1980s, when the authorities first introduced Saudisation requirements, but then did a U-turn as the initial results proved disappointing. This time, the situation may be different. There is clearly a greater willingness by Riyadh to stick with the plan, against the backdrop of social unrest in the wider region.

The government believes the disruption to the construction sector will prove a temporary blip and that the long-term economic effects will enable companies to share in the benefits. Many have yet to be convinced by that argument, but the scale of the opportunity in Saudi Arabia suggests most will be prepared to stay the course.

In numbers

9 per cent Growth reported in the Saudi construction industry in 2013

96 per cent Decline in operating profit in first quarter of 2014 for Abdullah A M al-Khodari Sons

Sources: Samba Financial Group; Al-Khodari Sons

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