Figure 1
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Economic Growth in the UAE and its Implications for Economic Policy
Economic policy results from the interplay between objectives and possibilities. The
objectives of policy in the UAE range from increasing the income of Emiratis, to expanding
their opportunities to find fulfilling work, to enlarging the contribution of the UAE to the
world’s scientific and cultural development, and to improving the security of the Emirates in
an unsafe world. Three areas of policy that influence the achievement of these objectives
relate to education, technology, and diversification. The possibilities of finding effective
policies to achieve the objectives depends on the way the economy works. I begin by
discussing that and then trace out the implications for policy.
In the 1960s when oil was discovered in the present day United Arab Emirates, its
population was only 100 thousand and the average income was exceptionally low. The UAE
was created as a modern nation in 1972. Since then growth in income and population have
been exceptional, and the UAE now has one of the highest incomes in the world. How did
this happen? What are the country’s future prospects?
The short answer to the first question is usually ‘oil’. Oil is, indeed, central to the
story, but its role is mediated by the economic structure that has developed to exploit it. This
structure is unusual compared to that of many other countries. Large countries like China, or
India, or the USA, are relatively self-contained. While there may be some migration, its
aggregate effect is small–the population expands mainly through natural increase. Again,
while there is some international investment, capital is mainly created by saving and investing
current GDP. Total output and income (GDP) increase as the population and the capital stock
grow. Technological progress also makes an important contribution. Since the population
grows at a rate independently of the economy, the factors that determine the growth in total
GDP also determine the growth in GDP per head. The growth rate of GDP is increased by
increasing the accumulation of capital or by accelerating technical progress or by raising the
intrinsic productivity of labour–notably through education, which is also called human capital
in this context. Indeed, increasing capital accumulation, accelerating technical progress and
raising educational attainment (or policies aimed to effect those ends) are normal
prescriptions for increasing economic growth.
Oil does not appear in this account of the causes of
economic growth. The reason is that the
UAE does not conform to this ‘standard’
model. There are many divergences. In the
standard model, for instance, GDP and GDP
per person grow together since the growth
rate of GDP per person equals the growth rate
of GDP minus the growth rate of the
population, and the latter is usually small and
approximately constant. This relationship
emphatically has not held for the UAE.
Figure 1 shows the course of the population
and real GDP since 1970. Both have
increased by large multiples, but population
has grown faster than GDP with the result
2
that per capita GDP has declined since the Fig 2
country was founded (Figure 2). This need
not be a cause of concern, however, since it is
still at a very high level. (The 1970 level was
truly extraordinary.)
The reason for the unusual growth
record is that the UAE has a very different
economic structure from that assumed in the
standard model. The UAE is not a selfcontained economy. Exports loom very large.
On the input side, the international capital
market governs the financial situation, and
immigration (not natural increase) is the major
determinant of the population. The only input
that is limited to domestic sources is what
economists call ‘land.’ In the context of the
UAE, ‘land’ means oil reserves or property for urban development.
These characteristics imply a simple architecture for the UAE economy: Exports are
the main driver of the growth in GDP. As exports and GDP expand, the demand for the three
factors of production–labour, capital, and land–increase. Labour and capital are available
abroad in unlimited supply at wage rates and interest rates prevailing in the source regions.
The result of an increase demand for these inputs is immigration and capital inflow at wage
and profits rates sufficiently above those in the sending regions to attract the flow. In the case
of land, however, the rise in demand raises its value. A rising value of oil reserves may
induce more exploration, drilling, and production. A rising value of urban land values may
induce a property boom with the construction of more residences and commercial structures.
A fall in exports reverses these effects.
Exports and extensive growth
This simple model requires some qualification and elaboration. I begin with exports.
The relationship between the volume of exports and the level of GDP is governed by a
‘multiplier’ relationship. The export of oil, for instance, brings money into the country.
Some of this is paid to people working in the industry as wages and salaries and much of it
accrues to the government as royalties. The people spend money on consumer goods and
housing, and the government spends money on development projects, the employment of
staff, the provision of education and health care, and the costs of the palace. The people who
receive this income spent it in turn. Each round of spending was less effect than the previous
round since some money is saved, some is remitted abroad, and some is used to buy goods
from abroad. In the end, however, the
total income of everyone in the UAE is
greater than the value of the oil sold.
A key question is: how much
greater is the total income compared to
the underlying value of exports? Figure
3 shows the ratio of GDP to the value of
exports of domestically produced goods
and services since 1970. There are some
3
fluctuations but the average ratio is 2.5–that is one dirham from exports creates an additional
1.5 dirhams of income in the UAE from the re-spending process described. The total income
is 2.5 dirhams.
The UAE is similar to many other economies that have developed by exporting a
natural resource and which rely on an imported labour force and capital to expand. In British
Columbia, where the economy is based on timber and mining, GDP was also about 2.5 times
exports from 1871 to 1981. The ratio was similar in Jamaica in 1832 where the economy was
based on sugar. In the eighteenth century, the ratio was a little over 3 in Pennsylvania (wheat
exports) and coastal south Carolina (rice exports).
In addition, Figure 3 shows no trend in the ratio of GDP to exports. This suggests that
there have been no fundamental changes in the structure of the economy over this period. We
will return to this issue later.
In the UAE, the growth in total GDP (extensive growth) has been driven by exports.
Labour and immigration
Immigrants account for 80-90% of the population and labour force of the UAE. There
are no official figures on where the foreigners come from, but figures collected from embassy
sources by Wikipedia indicate that 60% of the UAE population are south Asian, 18% are
from other Arab countries and Iran, and 12% are Africans, East Asians, or Westerners. Most
of these people have come to the UAE to work and earn more than they could have in the
countries they have left (or in other countries to which they might have emigrated with their
qualifications and passports).
Labour force surveys summarized by the International Labor Organization throw light
on the possibilities. Table 1 shows average monthly earnings as reported in recent surveys for
the UAE, the UK, and Pakistan. The earnings are expressed in 2011 US dollars at purchasing
power parity so they have comparable purchasing power. The UAE earnings are for people
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employed in the UAE (from whatever country), while the figures for Pakistan and the UK are
for people employed in those countries. It is clear from the table that people at all income
levels in Pakistan could dramatically raise their incomes by moving to the UAE and working
the same type of job. The Pakistan figures are representative of all of south Asia in this
regard. For UK residents, only skilled workers and professionals could improve their
situation by moving to the UAE (Service and Sales workers and above for men, clerical
support workers and above for women). This finding is also generally true for most European
countries and for North America and Australasia.
These possibilities are reflected in the actual employment structure in the UAE where
all low skilled jobs are held by non-Europeans, and Europeans are confined to high skilled
activities. When Asians and Arabs from other countries are qualified for the high skilled job,
there is an incentive for UAE firms to employ them since they may be willing to work for less
money than Europeans. In many cases, however, European salaries prevail and nonEuropeans in these jobs earn a premium over their alternatives.
In any event, the salaries in the UAE must be high enough to attract qualified labour,
and that means that the high skilled salaries exceed salaries in Europe and north America,
while low skilled salaries only exceed the low levels prevailing in south Asia. In both cases,
however, the UAE salary structure is determined by the foreign salary structure plus a
premium to make relocation attractive.
These considerations have another implication: The UAE salary distribution spans the
salary distribution of the whole world since the highest rung managers and professionals get
Western salaries plus, while the unskilled get south Asian salaries plus. This makes the UAE
one of the most unequal societies in the world.
Capital and international investment
An expansion of exports increases the demand for capital in the economy. Capital
includes oil wells, refineries, airports, roads, apartment buildings, shops, warehouses, and
factories of all sorts. A growth in oil exports, for instance, could induce the drilling of more
wells and the refineries to process the crude. The growth in exports could also induce a boom
in construction of housing and shopping centers to accommodate and service the expanded
work force needed to staff this capital.
In the first instance, most of this investment demand is financed from the income
received from oil exports. This may suggest that the UAE is independent of world financial
markets; however, this is not the case. Some of the oil revenue is also invested abroad by the
Abu Dhabi Investment Authority, a sovereign wealth fund. ADIA owns a wide range of
assets whose estimated value is on the order of $800 billion. Since oil income can be used
either to construct capital in the UAE or to buy financial assets in global financial markets,
the cost of capital in the UAE is the return in world financial markets, that is, the income that
is given up if physical capital is constructed in Abu Dhabi instead of investing the money
abroad. The same argument applies to private fortunes in the UAE as well. The upshot is
that the UAE can obtain capital at a price equal to the return on a similarly risky investment
in international markets. Investment in the UAE is not independent of those markets.
Land and the creation of rent
Capital and labour can move in and out of the UAE, so their prices are determined by
5
their next best use in the world economy. Land cannot move. When the demand for capital
and labour increases, more is pulled into the UAE and their returns are determined by their
value in the world economy. When the demand for land rises, however, its price increases
instead. These price increases are manifest either as real estate booms in the cities or as an
increase in the difference between the value of the crude produced by a well and its operating
costs.
The causes of extensive and intensive growth
The UAE has had positive extensive growth (growth in GDP) since 1970 and negative
intensive growth (growth in GDP per head) because the causes of these two types of
economic growth are fundamentally different. Extensive growth is due to the expansion in
the volume of exports. Intensive growth is determined mainly by conditions in the rest of the
world. The wage and salary structure in the UAE reflects wage rates in Europe and Asia. If
these regions develop economically and experience rising real wages and salaries, the UAE
has to match those increases to attract labour. The return on capital is probably even more
tightly linked to conditions abroad.
Apart from rises in real labour earnings abroad, there are only two ways that intensive
growth can occur. The first is if capital per worker is increased. Such an increase causes
profits per worker to rise. The second, and probably more important channel, is a rise in rents
on oil deposits and urban land. The very high per capita income generated in 1970 was
caused by enormous oil rents divided by a tiny population. This did not translate immediately
into high standards of living for Emiratis, however, since most of the money was spent on
investment. The rapid growth in population has meant that rent per person has continued to
fall and is the cause of the negative intensive growth shown in Figure 2.
Educational policy
What policies should the UAE follow in the realms of education, technical change,
and diversification in order to meet policy objectives? The answer depends on how the
economy reacts to the policies. I begin with education.
The standard prescription of most economists and international organizations is that
governments should provide very high levels of education to stimulate economic growth.
This recommendation follows from the standard model of growth in a closed economy: a
more educated work force is more productive, and the only way to get more educated workers
is to train your population.
The implications of educational policy are different in the UAE, however, because
training your population is not the only way to get an educated work force. In the UAE,
hiring abroad is the alternative. The upshot is that increasing the education of the Emirati
population does not lead to faster extensive economic growth–it merely displaces expats.
Likewise, increasing the education of Emiratis will probably have little impact on intensive
growth–GDP per head across the whole population.
The education received by Emiratis does, however, have a big implication for the
average income of Emiratis as well as other policy objectives. The labour income of Emiratis
depends on where they are slotted into the world wage and salary distribution, and that
depends on their education. In this respect, the UAE is fortunate that it has had such high
rates of extensive growth that Emiratis amount to only about one tenth of the population. The
reason is that there are enough high quality managerial and professional jobs for all Emiratis
6
to be employed at that level–if they had the education, ability, and inclination to do the work.
The situation is very different from Oman, for instance, where foreign workers amount to
only 40% of the population. At 60% of the total, there are more Omanis than high quality
jobs. In Abu Dhabi, south Asians and Africans drive taxis, while in Muskat that work is done
by Omanis.
A corollary is that the economic structure of the UAE creates remarkable possibilities
for Emiratis to have work that is personally fulfilling and that contributes to the cultural
development of humanity.
While the possibilities are great, so are the challenges. There must be enough schools
and universities to train the population. Also the education must be of high enough quality
that the graduates are qualified to do the jobs now done by expats. Finally, is this the kind of
life that most Emiratis want?
Technological progress
There is great enthusiasm for advanced technology like robots and artificial
intelligence. How would it affect the performance of the economy?
In the standard, closed economy model, more productive technology increases both
intensive and extensive growth. In many scenarios, it also increases real wages and salaries.
Historical studies show that there have been long phases of history (but not all) when
technology progress has had these favourable results. These are the reasons economists
usually endorse technical progress.
The impact of technical progress on the UAE economy are likely to be less
favourable. If technical progress cuts costs and improves the export competitiveness of
existing industries or leads to new industries that can profitably export, then the technical
progress will accelerate the rate of extensive growth. As a result, total GDP and the
population will expand.
The technical progress will have less impact on income per person. Wages, salaries,
and profit rates are set in international markets, so they are unlikely to be increased by
technical progress. If new technology requires more capital per worker, then profits would
rise and the extensive growth itself would increase the demand for urban land, so its value
would rise. Both of these developments are likely to increase income inequality in the
country as a whole and among Emiratis, in particular.
There may be reasons that a larger population is desirable–improved national security
or more interactions among a larger population of writers, artists, and thinkers that could
promote culture–but there are also negatives like greater inequality and increased pressure on
the natural environment. The question of how large the UAE should become requires careful
thought.
Diversification
Policies to diversify the economy do not find much support from the standard, closed
economy model. Many economists tend to argue that whatever meets the market test of
profitable production is probably a good thing, and attempts to direct the economy in other
directions are likely to be errors.
In the circumstances in which the UAE finds itself, however, diversification has much
7
to commend it. First, oil prices are extremely Figure 4
volatile (Figure 4). Reducing dependence on oil
exports would contribute to economic stability
since oil drives the size of the economy. Second,
diversification could increase national security
by reducing the dependence of the population on
imports of food, medicine, and other goods, as
well as the services of foreign specialists all of
which might be disrupted in times of war or
international tensions. Third, a diversified
economy would provide Emiratis with more
varied opportunities to develop their talents and
enrich their lives. Fourth, a diversified economy
would expand the opportunities for Emiratis to
contribute to cultural advance in the sciences and
arts.
The desire for diversification runs up against one great obstacle inherent in the
architecture of the economy–namely, the necessity to pay high wages to attract a labour force.
At the low skill end, how could a factory making clothing in the UAE compete with a factory
in South Asia when the unskilled labourer in the UAE is paid more than he or she could earn
making clothing in Pakistan or Bangladesh? Or, at the high end, how could the UAE
compete against Silicon Valley if it has to pay Silicon Valley salaries plus to attract engineers
of the same quality?
While the challenges sound daunting, there is reason to be optimistic. The UAE has
already bucked these trends and diversified its economy substantially. In the 1970s,
petroleum accounted for over half of the UAE economy. Construction and trade made up
much of the rest (Figure 5). By 2010, petroleum’s share had fallen to one fifth. Construction
and trade were still important, but they were joined by transportation and communications,
business and financial services, government services, utilities and other services as major
8
activities. These past successes raise the prospect that further diversification in the future is
possible.
Exports have also become more diversified (Figure 6). In the 1970s exports were
almost entirely petroleum. By 2010, petroleum amounted to half of the total. It was joined
by tourism, financial and business services, merchandise exports from free zones, and exports
of other UAE merchandise.
Figure 1 indicated that the ratio of UAE GDP to exports of goods and services was
trendless at about 2.5. The UAE remains an export driven economy. However, the ratio of
GDP to oil exports doubled from about 2.5 in the 1970s to about 5 in 2010 since oil
amounted to only half of the exports in that year. The rise in GDP/oil exports is another
indicator of diversification away from the resource base.
In recent years, the petroleum share has dropped to about a quarter. This has not been
a healthy development, however, since it was due to the fall in crude oil prices and has had a
negative impact on the economy. It is an argument for further diversification, not a sign of
success.
What of the future?
The low price of oil is also a harbinger of things to come. The underlying cause is
climate change: Global warming cannot be ended without reducing oil consumption. This
process is under way. First, solar, wind and other renewable technologies are becoming ever
cheaper. This is partly the result of Chinese central planning which ear marked solar power
as one of the industries in which it aimed to become world dominant. It has done so by
lowering the cost of solar panels and invertors. Solar is now the cheapest way to generate
electricity in much of the world and will soon be dominant everywhere. Wind power has also
9
become competitive. There is potential for state funded R&D to lower the cost of renewable
energy further.
Second, a carbon tax would also be effective in reducing the demand for oil and gas.
This is a popular policy recommendation among economists. As climate related natural
disasters become ever more frequent and undeniable, the political demand for policies to
limited global warming will become more insistent and carbon taxation inevitable.
The combination of commercial and state funded R&D to develop renewable energy
technologies and the imposition of carbon taxes will lower the demand of UAE petroleum
products. The price of petroleum will consequently remain low.
In the long run, the UAE will have to develop non-oil exports of goods and services or
see its economy and population shrink. The outflow of people and the drop in property prices
in recent years could continue. Even if these trends are reversed in the short run, an important
question is what size of population to plan for in the future. It is important to avoid
overshooting the mark by building housing and commercial space that cannot be sustained.
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