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UAE Economy: Time to 
Move Up the Value Chain

DUBAI - Recently, the World Bank announced that the global economy will likely enter a recessionary phase, defined as a period of below 3 per cent growth; in fact the World Bank predicts average growth rates well below one half of a per cent.

Despite this, the setback to the national economy is likely to be only temporary, even if the global credit crunch takes a year or two to dissipate.

The current crisis is ultimately a monetary phenomenon and is being addressed by world economies, including our own, with greater liquidity provision by central banks and higher levels of fiscal spending.

However, the current crisis should not mask longer-term challenges faced by our national economy, in particular diversification toward high value-added economic activities.

To be sure, much can be learned from business practices leading up to the crisis. For example, it is now well understood that the securitisation of debt instruments (in particular mortgages) has contributed to the gradual unravelling of the banking sector witnessed beginning 2007.

Creative financial repackaging of bad debts into mortgage-backed securities and accounting rules associated with so-called special purpose vehicles allowed both banks and the derivatives traded by their subsidiaries to be assigned risk and solvency ratings far more favourable than they actually deserved.

The story leading up to the current crisis suggests many ways in which national authorities, in association with international organisations, can effect regulatory changes in global banking activities. And while it may certainly not feel like it, the current crisis is essentially a short-run phenomenon. The success of economies in the long-run hinges on per capita income growth.

For example, in the decade following 1995, the UAE per capita income experienced robust annual growth rates of about 3.5 per cent compared to 1.65 per cent for the United States in the same period. Domestic per capita income is therefore slowly catching up with US figures: in 1995, income per person was about 35 per cent lower than the US, and by 2005 it was only 22 per cent lower.

Surely, diversification efforts by national authorities have contributed to the trend: over the same period, the overall population grew by an astounding 5.5 per cent per annum, driven mostly by the arrival of foreign labour in the non-oil sector.These numbers confirm that efforts at diversification away from oil have created many jobs in the non-oil sector, but they do not reveal the overall contribution of the non-oil sector to output growth.

During the period of 1995-2005, non-oil productivity (per worker output in the non-oil sector, measured in 2005 dollars) was about $28,000 in the UAE, or about 63 per cent lower than non-oil productivity in the US.

While greater economic diversification has contributed toward the creation of over a million jobs over this period, productivity gains in the non-oil sector have been lacklustre. Indeed by 2005, domestic non-oil productivity had grown by about 1.5 per cent per annum and reached $32,000. In the same period, US non-oil productivity had grown by about the same amount (1.45 per cent per annum) and reached $86,000.

So, for the period 1995-2005, domestic non-oil productivity has stagnated at a level about 63 per cent lower than in the US. In comparison, so-called Asian “growth miracles” grew by about 4-5 per cent annually in the decades following the 1960s; growth rates which ultimately led these countries’ economies to catch up to Western standards. Growth in these emerging economies was driven in large part by productivity growth above those of the West.

In contrast, domestic production data suggest that productivity in the non-oil sector is not contributing sufficiently to national output growth and lags behind overall productivity growth, which remains driven by the oil sector (and historically high oil prices). The numbers also suggest that non-oil output is still heavily dependent on retained earnings from domestic natural resources revenue.

To be sure, one would expect that private sector investment opportunities along with aggressive public sector efforts toward economic diversification would have afforded the non-oil sector rates of growth surpassing overall productivity, and yet overall productivity growth has surpassed non-oil growth by over 50 per cent during the period 1995-2005.

As the UAE economy moves away from oil revenue, its diversification strategy should focus on economic activities with potential for high valued-added productivity growth. Real-estate and tourism have created many jobs, but low productivity gains suggest that diversification toward these sectors is showing its limits. As international experience has shown since the 1950s, sustained economic growth (in real per capita income) requires substantial investment in higher education and sustained technological progress and transfer of technologies.

While the current crisis was triggered by the rise of “securitised” banking coupled with under-regulated derivatives markets and poorly designed international regulatory frameworks, the longer term challenge for our economy remains a move toward a higher value-added productivity landscape.

( Dr. Tarek Coury is an economist at the Dubai School of Government and the Harvard Kennedy School. )