Major Economic Reforms In Saudi Arabia?

WASHINGTON – What is going in Saudi Arabia? Probably too much. We have now an odd stew of engineered low oil prices that created huge economic and fiscal constraints, in Saudi Arabia and in other oil-producing countries, mixed with a new “Master Plan” for the country that includes extremely ambitious reforms unlikely to succeed.

Low oil prices 

Let’s look at oil prices. We know that the Saudis have willfully caused the global oil prices collapse that began in 2014, and continues today, by refusing to cut their massive output (in excess of 10 million barrels a day) when crude prices became soft on account of the extra supply created (in a very short time) by US shale oil producers.

With Saudi Arabia opposed to production cuts, the OPEC cartel had no choice. They had to endure the consequences of dramatically lower prices until Riyadh will change its mind. So far, it has not.

What is the end game? 

Why is Saudi Arabia doing this? Who knows really. I believe that this is an anti-Iranian move, and by extension, a move also directed against Shia dominated Iraq.

We know that for a while at least Saudi Arabia can afford to lose billions of dollars, the result of the lower prices it has imposed, because it can count on a significant financial cushion, in the neighborhood of $ 628 billion.

A huge price 

Still, it is clear that the Kingdom is already paying a huge price. The Saudi state depends almost entirely on its vast oil revenue to finance all public expenditures. Dramatically lower revenue means huge public deficits. Last year the shortfall was almost $ 100 billion. Again, the Saudis can afford to do this, at least for a few more years. But, at some point, their reserves will be gone. And then what?

Major reforms announced 

But this is not the only major development underway in Saudi Arabia. No, there is plenty more going on. Just as the Royal Family running the state is adjusting its policies to the lean years it has created, it came out with a new plan aimed at transforming the country. And this is no exaggeration.

The plan has been developed under the guidance of Prince Mohammed bin-Salman, the 30-year-old son of King Salman and now deputy Crown Prince. The young Prince (who is also Minister of Defense) is in charge of the Council of Economic and Development Affairs. The Council is a new institution established in January 2015, and placed in charge of planning future economic policies.

Privatizations, and a lot more 

Here are the highlights. There will be large-scale privatizations, including health care services. There will be a deliberate effort to move Saudi citizens away from cushy state jobs and into a soon to be created private sector (I am not making this up) that will not rely on the established oil economy. (Currently, two-thirds of all Saudi workers are employed by the state). There will be an end to fuel subsidies and other freebies.

In other words, the plan is to make Saudi Arabia into a modern, vibrant, innovation-driven, private sector-led economy, no longer dependent on its enormous hydrocarbon resources.

Slim chances of success 

In principle, this is not at all a bad idea. In practice, it all depends on the time line and the quality of both the plans and the execution. Let’s say this plainly. Usually these Grand Reform Plans do not work. And they do not work because the objectives are unrealistic, because people resist change, because sleek blueprints drawn by highly paid consultants fail to take fully into account the drag created by entrenched cultural habits and traditional mind sets. And in most cases all participants under estimate how long it takes for anything of substance to be implemented, and become eventually self-sustaining.

Abenomics failed 

Look, Prime Minister Shinzo Abe has essentially failed in his noble attempt to revitalize Japan. He called it “Abenomics”. And there was a lot of suggestive imagery built to support it. Abe talked about arrows in his quiver and how they would reach their targets. But it simply did not work.

And yet Japan is a highly advanced industrial democracy, with many world class companies, a modern state, and lots of highly educated people. Nonetheless, Abe’s Grand Plan, did not work. There is too much inertia, there are too many political, institutional and cultural obstacles. The Japanese people are unable to get out of their complacent, (and in the end self-destructive), mind set.

Now, if modern Japan cannot quickly embrace and own a vision of vibrant change, what makes Prince Mohammed think that sleepy Saudi Arabia, a country in which most people do nothing, (large numbers of foreign workers have been hired to perform most tasks), while oil money subsidizes the entire economy and society, will do much better?

In Europe, welfare reforms almost impossible 

Welfare and subsidies create dependence. Of course, in theory it is possible to wean people away from dependence on public largesse. But it is extremely difficult. Look everywhere.

In Europe all entitlement programs are essentially untouchable. Greece had to get all the way to the edge of the abyss before any political leader would accept the notion that the government had to reduce unaffordable social programs.

In other words, it took complete financial ruin before real reforms (this means cuts) could be contemplated. And even under those extreme circumstances reforms were fiercely resisted by most citizens.

Better results in Saudi Arabia? 

Given these examples, one needs a truly heroic level of optimism to believe that Saudi Arabia will eagerly embrace change and quickly transform itself into some kind of Big Singapore in the Middle East.

This is a country that lives under a heavy blanket of religious conservatism. It is an absolute monarchy in which basic human rights are unknown. Women are second class citizens. It is a nation where, beyond oil and refining oil products, there is essentially no other industry. And this is the soil where the leaders want to plant the seeds of innovation and modernity? Good luck to them.

May be in 20 years 

Look, assuming a perfectly modulated plan and a 20 to 30 years time horizon, some real changes may be possible. But the impression here is that Prince Mohammed is in a hurry. The perception is that we wants everybody to get busy, right now. “Give me a private sector-led, non-oil economy, today”. 

So, here is the thing. It is good to have bold dreams of modernization. But in the case of Saudi Arabia, this new reform plan looks a lot like lunacy.




China’s Economic Slow Down Will Have Political Consequences – Critics Argue That The Vast System Of State Owned Enterprises Is Wasteful – Reforms Ahead?

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By Paolo von Schirach

October 20, 2012

WASHINGTON – China is facing a major economic problem wrapped in a political problem. The emerging evidence is that the reformed, Deng Xiaoping vintage, economic model is not working so well anymore. The impressive impetus towards economic liberalization that began in the 1980s unleashed the creativity and ingenuity of tens of millions of entrepreneurial Chinese. Once it was established that making money was not inconsistent with a still dominant Communist political structure, China was on a roll.

China’s model

For decades China did extremely well because of the optimized combination of several factors: massive public investments in infrastructure that allowed manufacturer to deliver goods to foreign customers in record time, cheap labor, an under valued currency that favored exports and an almost perennial construction boom that enriched local officials and developers, while employing tens of millions. The entire growth strategy was financed through cheap capital provided by a state banking monopoly that could attract all private savings at almost zero cost.

As the economy grew at a fantastic rate of 10%, year after year, the Chinese Communist Party re-legitimized its political monopoly by transforming itself into a supercharged Chamber of Commerce, relentlessly pursuing economic growth.

The Chinese are masters at changing content while leaving the old labels intact. Mao is still on all the Chinese bank notes, even though this is no longer Mao’s China. Likewise, it does not matter that the Communist Party is no longer pursuing Marxist orthodoxy. What matters is that the Communist Party is still in power, retaining just as before an absolute political monopoly.

That said, there are signs that this ideal union between an ever growing economy and political control may not work any more. Let’s see why.

Not working so well now

First of all, China’s construction boom cannot continue at the same pace. There is just too much unneeded stuff. Too many empty office towers and even empty planned cities (such as Ordos, in inner Mongolia). There is brand new but underutilized infrastructure that creates no value. You cannot just keep adding more to it, simply to show higher GDP numbers.

Secondly, the vast price advantage provided by China’s cheap labor has been eroded. Chinese labor costs are growing, and so its exports can no longer be super cheap. Going forward, one can expect that they will reach parity with the West. At that point China will have to compete on quality rather than price. How many consumers in the West buy a product because of the superior quality of Chinese brands? They buy it because it is cheap.

Chinese economist argue against SOEs

Less construction and slower exports translate into slower growth. As all this is unfolding, some Chinese economist question the Keynesian model of more stimulus to be provided by more public spending. (See AP story: China’ New Leaders Face Tough Economic Choices, October 21, 2012). They argue, quite correctly, that in the long run this is terribly inefficient and wasteful. They point out that the still vast system of China’s State Owned Enterprises (SOEs) consumes wealth, while providing in the aggregate negative returns. (Some have estimated an average return on equity of minus 6%). The World Bank, working in conjunction with a Chinese think tank, recommended in March that China would undertake a major reform of its SOEs in order to regain economic efficiency.

Other Chinese intellectuals, (see many articles published in the magazine Caixin), have squarely accused the SOEs sector of being mostly a series of wasteful monopolies controlled by the politically connected to further their own power interests, as opposed to being wealth producing entities.

Politics and economics

That said, the very notion of reforming half or more of the Chinese economy, the half that is controlled by the state, is an almost impossible task from a political standpoint. And this is because the SOEs system is totally intertwined with the power structure. And the Chinese power structure, now determined by a system based on cooptation that favors continuity, is singularly unsuited to launch bold reforms.

The leaders who rise to the top in China are not reformers; they are skilled survivors who managed to avoid major problems on their way up. On top of that, the huge number of people who run the SOEs and benefit from them, whatever the inefficiencies of the system, have no interest whatsoever in any reform. In fact they will oppose any effort in this direction because for them this is a matter of personal political and econ0mic survival.

Unsustainable model?

Taking all this into account, without serious pro-market reforms, it is most likely that China’s incredible economic rise will end soon. This does not mean economic disaster, of course, only going back to “normal” growth. Still, much slower economic growth will allow Chinese critics of the current, inefficient set up to voice their discontent. (On October 13-14, the WSJ published an interesting interview with one of them, Zhan Wiying of Peking University). And since in China economic policy criticism implies some degree of political dissent, we may very well be on the verge of something quite dramatic.

Market economies and autocracy

In the end, what China did was incredible and unprecedented: several decades of sustained economic growth successfully managed by an autocratic regime.

Still, history shows that we can have sustained economic growth and we can have autocracy. However, in the long run the two are mutually exclusive. Post-Stalinist Russia failed. Semi-reformed China has done a lot better, but it may be close to running out of steam.




Will Greece Finally Exit The Euro? – Economy Is Too Weak – Current Austerity Focused On Higher Taxes, While Keeping A Huge Public Sector Makes Things Worse – Expect No Growth

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By Paolo von Schirach

May 24, 2012

WASHINGTON – The unmentionable is now openly talked about. Greece may have to leave the euro after all. Until recently this was considered a complete impossibility. Even talking about it was akin to blasphemy. The common currency agreements, we were told, do not contemplate an exit. Once in, you are in, for ever. But now there is at least talk.

Monetary union among unequal members was a bad idea

I am not sure of how a Greek exit, now often referred to as “Grexit”, a term coined by Citigroup analysts, could be arranged with manageable levels of pain and not too much market confusion. But I am sure that the whole concept of a monetary union linking together vastly unequal members was and is a bad idea.

Weak economies, bloated public sectors

The problem is that in Southern Europe the economies are not productive: there is hardly any innovation and no dynamic investment environment, while labor and other costs are too high.

At the same time, the political systems favor notoriously inefficient and bloated public sectors because public sector jobs are a way to soak unemployment while rewarding political friends. So we have the unhappy combination of weak economies and large public sectors that are both too expensive and totally unproductive.

After joining the euro, Greece and the others did not think even for a moment that they would need to reform in order to catch up with the more energetic Northern European countries so that they could actually stay and prosper in the common currency. No, absolutely not. They kept doing exactly the same, only borrowing a bit more to finance larger public deficits.

Wrong way to fix the problem

Now we are at the point in which the systemic weaknesses cannot be kept hidden any more. But the crazy answer is to rebalance the books through austerity that hits society and not by shrinking the bloated governments. A pro-growth austerity program, as David Malpass points in a WSJ op-ed piece, favors enterprise and the creation of new business activities, while shrinking the state via cuts in public employment and asset sales.

Well, in Greece they have done exactly the opposite. The state not only did not shrink, it actually grew a bit more, while it tries to get new revenue through impossible levels of taxation that are suffocating whatever economic vitality was left. And so the unproductive state with all its coteries of politically supported friends prospers, while society and the private economy, already in terrible shape, suffers even more.

This is a recipe for economic suicide. The idea that one can engineer economic recovery by taxing companies and people to death, (the same complaints can be heard in Italy and Spain), is ludicrous.

Southern Europe could adopt the Northern model

In theory it would be quite possible for the Southern European members of the eurozone to adopt the Northern models. There is nothing mysterious about recipes aimed at reforming public administration and taxation, while creating a new investor friendly environment. The Republic of Georgia did this. Some African countries have made significant progress towards this.

A matter of values and psychology

But I doubt that Greece and the others are willing to adopt Northern ways. The problem in the South of Europe rests in values and psychology. For most people a public sector job for life is much more appealing than taking a chance in the private sector. Nobody really considers the aggregate consequences of this collective predilection. A large and inefficient public sector consumes resources rather than producing them. High labor costs and rigid labor rules discourage investments.

With this approach, no solution

Unless something gives, the result is exactly what you see. Out of control debt that cannot be repaid because the economy is too weak. But instead of reversing course by cutting the public sector while encouraging new enterprise, they make the problem worse by adding to taxation while keeping the state just as large and unproductive as it was.

If this is the approach, I cannot see how these countries, starting with Greece, can share the same monetary union with more enlightened countries. Time to plan for Grexit.




World Bank And Chinese Think Tank Recommend Overhaul Of China’s Large System Of State Run Enterprises – A Surprise That Such A Sensitive Issue Is Publicly Debated – Economic Reforms Coming Up In Beijing?

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By Paolo von Schirach

February 25, 2012

WASHINGTON – Many believe that China’s spectacular growth rates are due to its ability to expertly manage a combination of state run corporations and relatively new privately owned companies. China seems to be the best and most successful expression of a mixed economy model in which state owned enterprises, SOEs, still control almost half of the entire economy, including most strategic sectors, such as banking and telecoms. But it would appear instead that China has done so well in the past 30 years in spite of state capitalism. And it would also appear that, in order to maintain a high rate of growth, China should make sure that going forward its many SOEs are run as real profit making enterprises, as opposed to being in large part powerful tools to assert government control over the rest of the economy.

China 2030

This is some of what is coming out of a preview of “China 2030“, a report prepared by the World Bank, (acting in an advisory capacity), jointly with the Development Research Center, or DRC, a very influential Chinese think tank that is supervised by China’s top policy-making body, the State Council.

Open debate?

What is most surprising about this report is not really the content, but the fact that it was commissioned in the first place and that its key finding and recommendation are becoming public. Just a few years ago, a document discussing issues that go to the very core of the Chinese state and economy would have never been aired in public. So, I would call this “openness” very good news. At least in principle, this is beginning to look like a debate on public policy.

SOE model worked well

As to the key findings, I am perfect agreement. China did very well in harnessing most of its national resources in a gigantic effort to create an export- led economy. It had all the key components to capture a huge slice of labor intensive manufacturing: cheap land for industrial sites, cheap capital provided by state owned banks and tens of millions of migrant workers willing to move into cities and work in factories for really low wages. What Chinese migrant laborers turned into factory workers lacked in terms of skills they compensated with low wages.

Chinese products, while not the best, especially at the beginning of this industrial effort, were certainly the cheapest. And so it did not matter that inexperienced Chinese workers were not particularly productive.

Besides cheap products, the Chinese were smart enough to understand that in order to gain and keep overseas customers they needed massive infrastructure investments. Cheap labor is a huge asset, but quick reaction time and time to market are equally important.

Tomorrow is about value

But this is the old story. Tomorrow’s story will be about quality, innovation and moving up the value chain. And here is where state run enterprise will show their weaknesses. And this is mostly because SOEs are still large bureaucracies run by government appointees. While China for sure has its own variation on the SOE model, by and large the state is not a good entrepreneur. It was fine when the matter at hand was to mass produce cheap consumer goods for Wal-Mart, with the obvious advantage of ridiculously low labor costs.

But now China has to assert itself by becoming a flexible, innovative and high quality producer. Even intuitively we can appreciate that a state run bureaucracy is not the best instrument to foster innovation. Invariably, SOEs are influenced by politics and tend to allocate resources on priorities that have little to do with increasing value. And, in the long run, this is their fatal weakness, be it in China or anywhere else.

Will there be serious reforms?

That said, reforming the Chinese SOEs system would be a monumental effort, precisely because SOEs are so relevant and so deeply entrenched in the very fabric of the political system. Still, if China wants to rise to the next level economically, this issue will have to be tackled.

Ironically, by privatizing –if it will come to that– large SOEs that have also been used as levers to exert political influence, the Chinese Communist Party would diminish its powerful grip on the Chinese society. Should serious reforms take place, how all this will end up is anybody’s guess. Meantime, we should welcome this Chinese debate, especially if it will be carried out in the open.




If There Is a Serious Crisis In Europe, Bad News for America – Economic Ties With Europe Are Huge – Problem Is That Washington Has No Tools To Protect US

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By Paolo von Schirach

September 25, 2011

WASHINGTON – Washington is hopelessly divided, while America is economically very weak. Yesterday I expressed my hope that nothing bad would happen on the domestic or international economic front between now and the November 2012 elections. Indeed, if something major did happen, the US government has no wiggle room, no tools, no money and no united policy on just about anything.

Something bad happening in Europe

Well, I am afraid that something bad is really happening in Europe. If so, this new turmoil will hit America, turning a bad predicament into a real mess. Europe is in the middle of a confidence crisis on the reliability of sovereign debt, while the economies of many EU countries are sputtering, adding another layer of pessimism. If investors start running away from EU countries sovereign debt there is no way to predict what will happen next.

Europe is divided

On top of that, if Washington is divided, the 27 countries that make up the European Union, of which a critical subset are the 17 that belong to the Eurozone, are divided, confused, unrealistic, superficial, many of them led by uninspiring governments. If all this does not change, a weak, fractured and leaderless EU may very well wander into the abyss without even realizing it.

Inability to contain the greek crisis

But why all the pessimism? Well, the pessimism comes from observing the EU inability to isolate the Greek problem. As bad as Greece was two years ago, the EU could have built a fire wall around it. But it did not. Greece is bankrupt. But the other EU countries treated an insolvency problem as if it were a liquidity problem. So they provided more liquidity in exchange for promises of reform, privatizations and serious effort to improve tax collection, among other things.

Greeks broke and unserious

But the Greeks are both broke and unserious. They do not realise that it is their responsibility to spend less, work more, pay taxes and be frugal for many, many years. The Greeks dream. While the country is collapsing, the Greeks protest. They riot, they stage strikes in critical sectors demanding no cuts in salaries. Thy want to keep their benefits, pensions and what not. The point is, they never got the message. And the EU institutions, beyond the Papandreu government in Athens, are to blame for this disconnect and for failing to isolate the problem.

Confidence crisis spreading across Europe

But this is not even the half of it. EU policies failed to contain the damage beyond Greece. It is clear that Greek debt is held all over across Europe. Knowing this, investors, fearing an eventual Greek collapse, now are looking at German and French banks that hold a lot of Greek debt with increasing suspicion. And their doubts have just been confirmed by recent downgrades of major French banks by the rating agencies. And the downgraded banks have seen their stock sink, thus adding another layer of gloom.

Italy in the spotlight

As they are at it, investors begin to wonder how other highly indebted countries, such as Italy, will be able to meet their obligations. This new wave of skepticism regarding the quality of sovereign debt has already caused huge financial pain for Italy, Spain and even France. Investors are now afraid that all this debt may not be paid after all. So they demand higher interest rates to buy it. And this complicates debt financing for countries like Italy whose total debt now exceeds 120% of GDP.

If debt service becomes more and more expensive for the Berlusconi government in Rome, then the entire budget needs to be redone. And this turns an alreday precarious Italian debt management policy into a potential nightmare. Italy depended on low interest rates to keep financing its astronomic debt. If the cost of borrowing increases, then drastic spending cuts become the only alternative.

Banks holding government bonds are shunned

The trouble is that in weak economies drastic spending cuts have a recessionary impact. If you cut public spending to make debt service possible, you simply take some more oxygen out of the room, paradoxically making the debt problem even more severe. Meanwhile, the “Greek disease” has spread to other banks holding Italian debt. So, lack of confidence in sovereign debt issued by some EU countries is having a cascading effect. At some point, as financial institutions across Europe are all intertwined, there is a serious risk that nobody would trust anybody anymore, not knowing exactly who is healthy and who is affected by bad debt.

America should worry

But why should all this matter for America? Very simple. It does matter because the EU countries, in the aggregate, form the largest world economic block. If some European countries are in a serious crisis, while the damage cannot be credibly contained, we should expect a recession, or worse, in Europe. As Europe is a major trading partner for America, a collapse of economic activities and contraction of demand there would have very negative repercussions for US exporters already plagued by weak demand at home. If Europe contracts and stops buying, expect major US producers to cut production and, yes, employment here at home, making a tenous situation really bad.

Washington has no tools

Can America help in any of this? Not really. The problems are too big and the US has no tools left. Treasury Secretary Tim Geithner has said publicly that the Europeans should devise new policy mechanisms to harmonize fiscal policies and otherwise create ways to stop the impact of the Greek bleeding. But he also said that he is confident that the Europeans will do the right thing, as this is absolutely necessary. Geithner believes that the Europeans know exactly what needs to be done and now are just devising the appropriate political process to get it done.

Pray that the Europeans will do the right thing

Well, Geithner is correct. But he also really disingenuous in predicting that eventually the right thing will be done. This is just about the same as saying that both president Barack Obama and House Speaker Boehner know what needs to be done to fix US public spending and now are just figuring out how to get to a political agreement. Yes, the problem is finding a political formula. But, guess what, just as their ineffective Washington counterparts, the hapless Europeans are utterly incapable of agreeing on anything fast. And this is precisely the issue. Something needs to be done and it is not done.

No consensus, conflicting ideas

And so, German Chancellor Angela Merkel, French President Nicolas Sarkozy and all the others are circling around the problem with no new policy consensus in sight. In the meantime, in this policy vacuum, all sorts of conflicting ideas are floating. And this is damaging, as confusion reinforces the perception of disarray. Here are some samples:

Greece should stay within the Euro.

No Greece should get out.

There should be no Greek default.

No, we have to think of an “orderly restructuring” for Athens, (a polite way to say bankruptcy).

The Eurozone has too many undeserving members.

No, the Eurozone cannot be touched, as tinkering with it might cause the unraveling of the entire EU.

The European banks are in good shape, as they passed a “stress test” only a few months ago.

No, the “stress test” did not test much of anything, and thus it is inconsequential.

We trust the Italians to launch credible spending reforms that will stabilise their debt situation.

No, we do not trust them, as their government is led by Silvio Berlusconi, a perennially indicted Prime Minister surviving who knows how and happy to close each day while still in office. Besides, the Italian economy is not competitive and does not grow at all, not creating the surplus required to start paying back all that debt.

America bracing for the worst, with no protection

Given all the nasty stuff brewing in Europe, America should be prudent and prepare for the worst. The problem is, and Geithner knows it, that America is bracing for a possible hurricane with the protection of a few mended tents and not much else. The US shelters are under repair and we do not even have emergency rations, while the people in charge of operations are fighting one another.