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A liberal economic strategy

posted on 02/12/2006: 1502 views



When the UAE achieved independence in 1971, it did so in a changing and uncertain world. From the economic perspective, the 1970s was a turbulent decade.



First, the dollar lost its convertibility to gold, and the demise of the Bretton Woods system meant that the world moved towards floating exchange rates, with resulting volatility.



Second, the oil shock of 1973-74 quadrupled oil prices from $3 to $12, leading to stagflation in the West, as real income fell and inflation rose. Suddenly, the long- reigning Keynesian orthodoxy of a usable trade-off between inflation and employment was destroyed. High inflation was accompanied by rising unemployment in the US and Europe.



Third, as a result of the Arab oil embargo, a wedge was driven between the West and the oil exporting countries. A geopolitical strain developed, culminating with the overthrow of the Shah of Iran and, later, the outbreak of the eight-year war between Iran and Iraq.



Fourth, a second shock in 1978-79 led to an escalation of oil prices from $12 to $31 a barrel which brought in huge revenues for the OPEC countries, but an investment dilemma in terms of the recycling of the surplus petrodollars.



But the windfall in energy resulting from high oil prices during this era signalled the beginning of the economic transformation of the UAE. The once-subsistence economy embarked on a path of development of social and economic infrastructure.



The oil sector has since dominated the growth and finance of the country. Abu Dhabi and Dubai have been the main beneficiaries of oil revenues. But Abu Dhabi's dominance is clear with its proven crude oil reserves of 92 billion barrels comprising 94 per cent of the UAE's total reserves and 8.6 per cent of the world's oil reserves. According to the Ministry Of Economy, in 2005, Abu Dhabi was the main contributor to the UAE's GDP, and almost 56 per cent of the emirate's GDP was derived from oil. Oil's direct share in Dubai's GDP was only five per cent.



While oil has remained critical to the UAE's economy, the pursuit of a liberal economic strategy away from oil dependency in recent years has contributed to a significant diversification into trade, manufacturing, real estate, tourism, financial services and banking. Today, the economy is less dependent on oil exports when compared to other countries in the Gulf.



Evolution



Even so, for the last 35 years the UAE's growth story has predominantly been an oil price story while volumes have risen from 1.26 million barrels a day in 1985 to 2.36 million barrels a day in 1995, and have remained more or less in that vicinity for the past 10 years (see chart). Fluctuations in global oil prices have significantly impacted the country's growth pattern.



During the mid- and late-1970s, rising prices led to large current account surpluses and development picked up. Between 1975 and 1980, GDP (at constant 2000 prices) grew from $29.4 billion to $40 billion. The UAE's per capita GDP increased from $16,200 in 1975 to $29,300 in 1980, making it one of the highest in the world. Since 1981, the dirham has been pegged to the US dollar at the rate of 3.67. With oil priced in US dollars and the UAE having huge investments in the US, it was felt that the dirham's pegging to the dollar was the best course to achieve currency stability and to avoid macroeconomic uncertainty.



Oil prices went downhill from $34 a barrel in 1981 to $9 a barrel in 1986, largely because of the global recession in the early 1980s. Oil revenues virtually halved, from $19.4 billion in 1980 to $10.9 billion in 1985. The UAE's GDP fell to $38.77 billion in 1985, with per capita declining to $19,800.



With the sustained recovery of the global economy in the late 1980s, oil prices increased. Iraq's invasion of Kuwait caused oil prices to spike, pushing the GDP up to $42.8 billion in 1990.



Because of flatter and declining prices in the mid-1990s, oil revenues fell to $12.2 billion in 1995. In fact, oil slumped to a low of about $10 a barrel in 1998, prompting the re-evaluation of the option to diversify the economy.



Since 1999, oil prices have recovered, surging to the historic levels of almost $78 a barrel this year. In five years, GDP has grown from $70.3 billion in 2000 to $97.7 billion in 2005. Oil revenues more than doubled from $21.7 billion to $43.5 billion during the same period.



Diverse economy

Though oil's share of GDP has declined, it still remains substantial at about 27 per cent, up from a low of just 20 per cent in 1998 when oil prices slumped, but significantly down on the 60 per cent reported over the 1980s. This reflects the greater diversity of the economy.



The lesson of past swings has been learned, and the commitment to economic change sustained.



However, these figures understate the oil sector's continuing, real importance to the economy, as oil earnings still form the core of government income, with revenue determining the public-sector expenditure on which much of the non-oil economy directly or indirectly relies.



Non-oil GDP has continued to grow rapidly, accounting for 73 per cent of total GDP in 2005. The major non-oil sectors (in 2005) include manufacturing (20 per cent), trade (17 per cent), real estate (12 per cent), construction (11 per cent), transport, storage and communication (10 per cent) and finance (nine per cent).



In the drive for diversified economic growth and ensuring full employment for nationals, it was imperative for the UAE to open up the economy to the private sector, attracting both local investors and foreign investment.



WTO membership

To gain from globalisation and facilitate international trade and services, the UAE became a member of the World Trade Organisation in 1995. It is also in the process of signing free trade agreements with several countries, including EU, China, the US and India.



At the regional level, the UAE is an important member of the Gulf Cooperation Council, a body established in 1981 to boost economic ties among the Gulf countries.



The UAE economy today is the second largest in the Arab world and the robust growth of the last five years is expected to continue despite a decline in oil prices. Analysts see the economy growing steadily at about six to seven per cent in the next two to three years. However, what is worrying is rising inflation, particularly seen in the housing sector, that could undermine the competitiveness of the UAE. It has been variously measured between four and 14 per cent this year.



With 47 banks, almost equally of domestic and foreign names, the UAE has meanwhile grown into an important financial centre. The capital markets have evolved into more formal institutions with the creation of Abu Dhabi Securities Market and Dubai Financial Market.



This year's stock market slump - a much-needed correction, according to experts - can even be taken as an example of the maturing of the UAE economy as it integrates into the global economy.



Alternative paths

Within the federal structure, the UAE's economic growth can very well be termed as a tale of two developments.



The dominance of oil provided Abu Dhabi with a cushion that Dubai lacked. So, while it weakened Abu Dhabi's incentive to diversify early on, Dubai came to epitomise that "necessity is the mother of invention.” Well aware that its oil reserves are expected to last only 10 years, Dubai adopted a market-friendly approach, making a serious impression on the world stage.



Today, Abu Dhabi and Dubai remain the main economic engines driving the economy of the UAE. While Abu Dhabi contributes about 59 per cent of the GDP, Dubai's share is around 29 per cent.



Dubai has come into its own in the last five years, feverishly pursuing diversification of its economy and encouraging privatisation. Oil's share of Dubai's GDP, according to a DCCI report, was 10.3 per cent in 2000 and dropped to 5.4 per cent in 2005. It has become a major trade hub, re-exporting goods through its free zones.



Retail tourism has made Dubai a shopping paradise for millions of people coming from around the globe. In the realm of real estate, Dubai government's freehold property law promulgated early this year paved the way for increasing investments from abroad.



Abu Dhabi and the other emirates, following Dubai's lead, are diversifying their economies in a similar way. Today, the other emirates get to pick and choose development projects and avoid some of the pressures on infrastructure that have been the flipside of Dubai's success story. (Gulf News)

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