November 4, 2005

In Kuwait, Gush Of Oil Wealth Dulls Economic Change

Government Spending Surges,
As Perks Flow to Citizens;
Long-Term Woes Put Off
Ms. Jaafar's Plush Villa
November 4, 2005; Page A1

KUWAIT CITY -- When the price of oil climbed above $35 a barrel in the summer of 2004, Kuwaiti officials revisited their budget forecasts. With oil at $15 a barrel when the budget was put together, they had anticipated a $10 billion government deficit. Suddenly, they were looking at a $9 billion surplus.

This was very good news for Kuwaitis like Madelene Al-Jaafar, a 63-year-old widow with three grown children.

Ms. Jaafar estimates she's received about $45,000 in additional subsidies and cash handouts from the government since then. These include a $688 payment she collected along with each of Kuwait's one million citizens, a waiver for a decade of unpaid electric bills, a hefty bonus for government workers -- including retired ones like Ms. Jaafar -- and a payment of more than $15,000 to help her build a home.

Meanwhile, she's benefiting as Kuwait City undergoes an extreme makeover, with plans for new skyscrapers, waterfront shopping malls and a highly subsidized bus system with luxurious shelters and very short waiting times. A new municipal waste project promises to be "the greatest sewage system in the world."

With Kuwaiti crude, which is heavier and more packed with sulfur than some other grades, fetching more than $50 a barrel recently, government officials are "really looking out for us in a way they never did before," says Ms. Jaafar.

Soaring oil prices are generating the largest revenue windfall ever for the world's petroleum exporters, surpassing even the waves of petrodollars produced by the oil shocks of the 1970s. And compared with the spending binge back then, big Persian Gulf oil producers like Saudi Arabia, Kuwait, Iran and the United Arab Emirates are generally winning plaudits this time for managing their fast-rising revenue. These countries spent about 60% of the additional export income brought in during the 1973 oil crisis, compared with about 25% this time around, according to the World Bank.

Saudi Arabia, the world's largest oil exporter, has paid off a mountain of foreign loans. Kuwait put almost $3 billion of last year's oil revenue into its Reserve Fund for Future Generations, a piggybank for when oil revenue dries up or other emergencies. Even some smaller places are pushing ahead with economic changes, despite the flood of new money. Abu Dhabi recently loosened its grip on the property market, which had long been sealed off and used as a way for the sheik to cement his hold on power.

But the oil boom also presents a challenge for Gulf countries. They face growing pressure to open up their economies and wean away from a dependency on oil. The gusher of oil money today could undermine that long-term goal.

As populations in the Middle East explode, some 80 million new jobs must be created across the region in the next 15 years just to keep the employment rate at its current level, according to Augusto Lopez-Claros, chief economist at the World Economic Forum. Without a major opening of the economy to market forces, "this goal is unattainable," says Mr. Lopez-Claros.

The International Monetary Fund recently warned Kuwait that even with oil revenue booming at today's levels, it could exhaust its reserves in as little as 25 years and be forced to borrow at an unsustainable pace to keep living standards steady.

Meanwhile, other countries are also struggling to keep perks under control amid the gush of new revenue. Saudi Arabia gave government employees a 15% raise this year. And Qatar announced a waiver of electricity and water charges earlier this year, which will cost the government $400 million annually.

Whether countries like Kuwait avoid complacency is important to the rest of the world. The Middle East's stagnant or falling living standards may be partly to blame for the terrorism that's emanated from the region. And political instability is always worrisome in a region that provides 45% of the world's oil.

"The surge in religious extremism we witnessed in the past is a direct result of the lack of foresight by the government during oil booms," says Musa AlSayaad, a Saudi economist. "When [oil] prices dropped, they couldn't give the people the subsidies they expected. They were left with a youth population that was jobless. That translated into anger."

Yet few things induce complacency like higher oil prices, according to those who want to see the economy modernized. "Oil prices begin to climb, and immediately the government sits back and relaxes," says Ali Al-Mousa, chairman and managing director of Kuwait's Securities Group investment bank and a former minister of planning. "Visit any government office and you can see it today."

The Gulf's unique combination of exceedingly young populations and elephantine public sectors presents the risk of a fiscal time-bomb, supporters of change argue. Almost two-thirds of Kuwaitis are under 20 and will soon want jobs.

They'll expect to find them with Kuwait's employer of first and last resort: the government, which promises a salary to any citizen who wants one. Almost all Kuwaitis who work are on the public payroll.

In 2004, 40% of Kuwait's $21.5 billion national budget went toward payroll, according to Kuwait's Ministry of Planning. An additional 30% of the budget went to public subsidies for basic services like electricity and handouts of cash.

Beginning With the Basics

Oil was discovered in Kuwait in 1938. By 1950 the leadership had sown the seeds of a welfare state -- giving out cash, land and housing. Pearl diving, the country's previous mainstay industry, began to shrivel.

Kuwait's welfare state really put down roots in the 1960s, when oil revenue multiplied and the country declared independence from Britain. It began with the basics: Free education, free health care -- including full coverage for treatment abroad -- and subsidized goods. Electric power, for example, costs Kuwaitis about 10% of the market price. That is no small thing in one of the hottest countries in a hot region, where residents typically run their air-conditioning year-round. Fuel prices are heavily subsidized.

Meanwhile, a new constitution gave every Kuwaiti the "right to work," which basically translated into a guaranteed government job. Most jobs amounted to government sinecures, requiring little time or talent. The real work was handled by legions of foreign workers. Meanwhile, the benefits to being Kuwaiti became ever farther-reaching.

When Ms. Jaafar got married, the government gave her and her husband $17,150 to help with expenses. The couple also received free land, a car and cash to help build a house. Their expenses were minimal: electric bills, which often go unpaid, were almost nothing. Subsidized food made basic meals close to free. On her 10th anniversary, a congratulatory check for nearly $250,000 arrived from the government. Ms. Jaafar retired after 15 years in her government job of three hours a day. But her pension still brings in 95% of her previous salary, which was $4,116 a month.

Kuwaitis wanting to invest in the stock market can get interest-free loans -- something Ms. Jaafar recently did to cash in on the stock-market boom. Interest-free loans are also available for travel abroad.

Some members of the National Assembly are lobbying for the government to forgive these individual debts -- just as the government recently did for unpaid electric bills. They quote Article 20 of Kuwait's constitution, which stipulates the aim of the national economy includes providing "prosperity for citizens."

Ms. Jaafar, who favors bright colors and loves to shop and travel abroad, lives in a spacious three-bedroom villa with large windows overlooking the garden. She trusts the system that delivered her a comfortable life will do the same for her children and grandchildren. Her two eldest sons already work for the government. They just received pay raises and new villas as part of the government's newest subsidy spree. Her daughter is married with kids of her own.

But global financial watchdogs like the IMF and others pressing for change say she should be worried. They started warning countries like Kuwait decades ago that their penchant for giveaways and subsidies -- especially ones that created incentives for ever larger families -- were a recipe for problems.

Most Gulf States didn't listen. That began to change when oil prices fell below $20 a barrel in the 1980s -- but progress has always come in fits and starts. Kuwait, which had the added cost of the Gulf War and subsequent reconstruction, saw its accumulated deficit grow to $48 billion by the early 1990s.

The country embarked on a major initiative to privatize government operations, encourage foreign investment to provide jobs and training to Kuwaitis and nurture parts of its economy not directly connected to oil. Urged on by the World Bank, the government-controlled Kuwait Investment Authority sold off major stakes in 17 companies between 1994 and 1996, promising more would follow.

But putting government operations into private hands, which Kuwaitis worry will be followed by job cuts and less-equal distribution of income, hasn't been popular. Only about $1.9 billion of the $12 billion of planned privatizations were carried out during the 1990s. Kuwait only recently granted its first operating licenses to foreign banks, after 15 years of debate. The country also only recently granted foreigners the ability to own 100% of locally based companies.

As oil prices have marched higher, momentum has dissipated even further. Kuwaiti officials rarely ascribe the urgency they once did to economic retooling, and some see little need for change at all.

A Five-Year Plan

Ali Abdel Gader Ali, deputy director general of the Kuwaiti-based Arab Planning Institute, a regional think tank, consulted closely with government officials to create a five-year development plan for Kuwait. He says encouraging Kuwaitis to enter the private sector wouldn't hurt. But he doesn't see any need to drastically reduce the public payroll or spur the private sector. With oil revenue high, handing out government jobs to all takers accomplishes what he says is the government's main role: "the redistribution of this wealth to citizens," he says.

There are other signs the appetite for change is fading. The percentage of working Kuwaitis on the government payroll has risen to 96% from 80% two years ago. Spending grew by 14% this year, on top of 12% growth the year before -- the fastest growth in two decades, according to the National Bank of Kuwait.

Meanwhile, a plan to invite foreign companies to participate in Project Kuwait, a massive effort to expand the country's oil production was recently shelved once again. It would have been the first time foreign firms were allowed into the oil industry, something backers hoped would bring in new ideas and technology that would ultimately help Kuwaitis acquire new skills. But the country's National Assembly has consistently rejected the project to prevent foreigners from profiting from Kuwait's natural resources.

The episode shows how Gulf countries' experimentation with more participatory, democratic governance -- in part at the urging of President Bush's Middle East democracy drive -- could slow economic changes even further. Kuwait's National Assembly is elected, and it's among the most active and responsive to constituencies in the region. Although the ruling Emir and the government have the final word, they've been reluctant to flout the elected body's collective will.

But the National Assembly is packed with populists devoted to defending the country's welfare state. Members know that delivering gifts and subsidies to their constituencies wins votes. That means legislation aimed at paring back the government's overwhelming role in the economy often gets stalled in the assembly.

Yousef Zalzalah, who serves on its finance committee, sees changes in how the economy operates as crucial. But he concedes that he sometimes pauses at supporting government privatization plans. "The problem with us is that we want things now -- for ourselves and our constituencies," he says.

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