The discovery of the first Gulf oil deposits in Bahrain in May 1932 took place in a region that was poor, sparsely populated and in major economic turmoil. Oil became the deus ex machina that revived the economic fortunes of the Gulf economies, but also fundamentally reshaped their economic model.

The oil concessions were granted by governments that became recipients of rocketing oil revenues as the industry boomed after the Second World War. Gulf governments positioned themselves as drivers of socio-economic development. Initially, this outcome was more by default than by design.

Even as the oil-government nexus established itself, it began to be questioned. This was because of anxiety about the finite nature of the oil wealth and the desire to develop local human capital and increase employment.

Economic diversification has remained a central focus of the GCC governments’ economic vision statements ever since.

Renewed economic stimulus

Despite this consensus around diversification, an “old new” element has recently crept back into the regional economic narrative.

After a period of aggressive fiscal consolidation, several Gulf governments are once again seeking to stimulate economic activity through increased stimulus spending. Broadly speaking, three factors are driving this.

Firstly, the more comfortable oil price environment has increased the fiscal space available to many GCC governments.

Secondly, the marked reduction in non-oil trend growth across the region shows the private sector response to the economic overhaul is seldom instantaneous.

Lastly, the monetary policy backdrop has grown tighter because of interest rate increases by the US Federal Reserve, as well as the partial reversal of capital flows to emerging markets.

Beyond these cyclical considerations, the governments continue to drive the regional development agendas. These involve ambitious investment projects requiring large amounts of long-term capital, such as the Etihad Rail and Saudi Landbridge projects, power generation, housing and even manufacturing.

Private sector involvement

Even in areas where government participation is optional, it may make strategic sense. This is not just because of the governments’ position as key repositories of wealth, but also because many of these investments are good for development and promise attractive long-term returns.

The ability of the private sector to substitute for the government has improved, but continues to face some challenges.

Regional financial markets still have a relatively limited toolkit for long-term lending and investment. This is partly because the kinds of institutional capital pooling and management mechanisms that dominate the investor landscape in many other countries are underdeveloped.

Insurance funds and private and occupational pension funds – long-term investors par excellence elsewhere – are of particular relevance in this regard.

However, driving economic development is almost as much an art as it is a science. Policies must be implemented in ways that work not just on paper, but also deliver the desired results. The reforms of recent years have delivered much, but require ongoing evaluation.

Future-gazing

The longer-term strategic priorities for the region remain firmly in line with the ambitious visions of the GCC governments.

While the hydrocarbons era is far from over, technological change has laid peak oil theories to rest and created a major challenger in North American shale.

Changing investor preferences around the world, largely in response to climate change, are also pushing people to rethink the role of hydrocarbons as an energy source.

Even with the economic model evolving, governments will always have a role in countercyclical growth promotion and strategy implementation.

Public capital will still often be necessary to ensure timely project implementation and to manage various risks that the private sector might be less willing to take on. But even in these areas, the posture assumed by the GCC governments is changing.

Supporting change

Several state-owned enterprises and government-run projects have been, and continue to be, privatised. Efforts to bring private capital to the development and management of infrastructure assets like the Saudi airports is a case in point.

Moreover, governments continue to drive the paradigm shift through other means. A key theme of the recent past has been the unprecedented focus of regulatory and institutional reform to encourage and support private entrepreneurship.

In sectors such as education and healthcare, governments have made it much easier to provide private alternatives to public services. These trends are making the private sector a more central driver of economic development and an increasingly credible alternative to the public sector.

About the author

Jarmo Kotilaine is the chief economist at the Bahrain Economic Development Board

More from this month's Agenda

• Main Agenda: Governments lead new era of investment
• Comment: Recovery in oil prices triggers a return to spending
• Infographic: Money in the bank