XI. CONCLUSIONS

Saudi Arabia is in a financial bind that will probably worsen in coming years. This trouble stems from the fact that, following the oil shocks of 1973-74 and 1979-80, the Saudis raised state expenditures precipitously-and often very wastefully. When oil prices and revenues then began to drop sharply after 1981, the regime was unable to implement the necessary reductions in expenditures, resulting in the emergence of large and persistent deficits. In a sense, the regime trapped itself into the high-spending patterns of the "fat years" that it can no longer afford.

Any significant cutbacks in the wide range of subsidies will be resisted by powerful interest groups or by the population at large. The Gulf War and its aftermath raiscd current and future military expenditures to even higher levels than those that prevailed in the 1980s. Moreover, since public spending, based mainly on oil revenues, continues to be the engine of growth, serious budget cutbacks would have recessionary repercussions throughout the economy. The high rate of population growth requires a continued expansion of expenditures on education, health, and other services provided free-of-charge by the state. The massive expenditures on infrastructure in the boom years require large and continuing outlays for operations and maintenance. The extremely low (i.e., highly subsidized) prices charged for water and electricity (and other goods and services) stimulate a rapid rate of growth in consumption, requiring large-scale imports and additional investment in water supplies and electric power. The "kickbacks and commissions" received by the extended royal family and other influentials add billions of dollars annually to the drain on the state treasury.

Every year since 1983, Saudi Arabia has incurred large budget and balance of payments (current account) deficits. Until 1987, they were covered by drawing down the bulk of financial reserves (foreign assets) accumulated in earlier years. Since 1987 there has been increasing domestic borrowing, and since the Gulf War there has been a greater recourse to external loans and credits. The sharp drop in foreign assets held by the state was soon followed by a strong decline in dividends and interest from abroad that had also been a substantial source of government income in the early 1980s. At the same time, the growing public debt necessitates rising budgetary allocations for payment of interest and principal to the creditors.

If expenditures cannot be seriously curtailed, another way for the treasury to raise income would be taxation. Imposing an income tax appears highly unlikely, however. A royal edict announced in December 1987 did impose an income tax on the more highly-paid foreign workers, but it was withdrawn a few days later when Saudi businessmen expressed strong opposition, since they would have had to bear the burden of the tax in order to retain their employees. If spending cutbacks and general income or sales taxes are politically taboo, that leaves Saudis hoping for an improbable increase in oil revenue.

Saudi Arabia is by no means the only financially strapped oil exporting country. Iran, Kuwait (since the Iraqi invasion), Venezuela, Nigeria, and Algeria, as well as a number of non-OPEC oil producers, are also facing serious or severe financial problems and are expanding their productive capacity in order to increase oil exports and, they hope, revenues. Importantly, excluding the former Soviet Union and the United States, there has been steady and significant growth in oil production in a wide range of non-OPEC countries. There is every reason to assume that this trend will continue, especially due to the far greater involvement of Western oil companies in exploration and development. In the United States, oil production has been declining since the mid-1980s, though new technology holds the promise of retarding the rate of decline.

It appears that the growth in world oil demand will lag behind the prospective increase in supplies. Energy efficiency has been improving almost steadily since the 1973-74 oil shock, while at the same time there has been a steady displacement of oil by other sources of energy. The year-to-year changes in both energy efficiency and fuel substitution are not spectacular, but their cumulative effect is powerful. In recent years there has been large growth in natural gas reserves almost world-wide, and the movement for a cleaner environment has provided additional impetus to the displacement of oil by natural gas. New technology has increased both the success rate of exploration and the recovery rate of oil extraction from existing wells. In short, the prospects are for increasing supplies and sluggish demand, which will put downward pressure on oil prices. Moreover, the eventual reentry of Iraq into world oil markets and increased exports from the former Soviet Union threaten to intensify the current oil glut in the coming years.

OPEC was never a strong cartel. It usually followed the market rather than lead it. The rise in prices in 1973-74, in 1979-80, and more recently during the Gulf crisis, were all caused by exogenous events, not by OPEC decisions. OPEC's attempts to curtail the downtrend in prices since 1982 have had very limited and short lived success. New quotas established by OPEC every three or six months were soon followed by "cheating" by some members who had the productive capacity to exceed the quotas. In the first half of the 1980s, Saudi Arabia absorbed much or most of the decline in world oil demand; since 1985, it has refused to do. Its increasingly precarious financial situation has dictated a policy aimed instead at the expansion of sales. The financial problems of other oil exporters make them equally anxious to augment sales. OPEC may continue to hold meetings but its efficacy will suffer from further erosion.

This analysis suggests that the underlying trend in oil prices will be downward, at least when measured in constant (inflation corrected) dollars. This does not necessarily imply a smooth downtrend in prices. They will surely fluctuate. Seasonal changes in demand, extreme weather conditions in the main oil-consuming countries, and accidents will cause prices to vary. Revolutions and wars in one or more major oil-producing countries can have a powerful impact on oil prices. But after each oil shock the trend toward improved energy efficiency and oil displacement receives an additional boost, and oil companies seek to diversify their supplies by increasing exploration and development outside the volatile Middle East. Within a few short years another oil glut appears and depresses prices to levels even lower than those prevailing before the latest crisis. Measured in real dollars, prices today have returned to their 1973-74 levels and are probably heading lower.

For the United States and the large majority of oil-importing countries, both rich and poor, lower oil prices tend to reduce inflation, improve their balance of payments, stimulate economic growth, and increase employment and income. However, for countries highly dependent on oil revenues, this spells serious troubles ahead. The policy of the Saudi regime can only be described as trying to muddle through, in the hope that external events will raise oil prices and revenues. The Saudi regime can and probably will continue to pile up debts in order to postpone difficult decisions that might create or increase unrest. But sooner or later, this dam will burst.

There are reports from Saudi Arabia indicating growing internal disaffection. Unemployment among the rising number of high school and university graduates has reached politically dangerous levels-25 percent according to one unofficial estimate-and unless the authorities create more make-work jobs in the bureaucracy (thereby exacerbating the state's financial problems), unemployment among young Saudis entering the labor force may reach even higher levels. The income gap between the extended royal family, including the thousands of princes and others in high government positions, and the large majority of citizens has widened. As an observer noted, "[t]he middle class is growing resentful of nepotism which gives control of jobs and contracts to the ruling family and those in high government positions. As the Wall Street Joumal reported:

Years of mismanagement, corruption, and budget deficits have left schools overcrowded and many young Saudis unemployed. . . . many Saudis are struggling.... [Mlany can afford little beyond basics. [M] any also cannot find jobs. The bloated public sector can no longer absorb every young Saudi, and the private sector prefers cheap well-trained foreigners to Saudi graduates. . . . Despite years of state prodding, private sector employment remains only 10 percent Saudi.... The infrastructure and welfare state built in the boom years..... are starting to creak.... Doctors often deliver babies in the emergency room because hospital beds are scarce, and handouts such as no-interest housing loans require a wait of five years or more.... Across Saudi Arabia fundamentalism is particularly strong among the young. . . . Economics is one reason.... Saudis note the gilded palaces of the royal family and the practice that allows princes and their retainers to rake off 30 percent commissions for business transactions. . . . Many Saudis wonder how well the state can weather the next crisis, whether [as a result of] the death of the king, a fall in oil prices, or a fresh military challenge.

In 1992, 109 Islamic scholars sent a petition to the king calling for an end to royal palaces for princes built at public expense, public disclosure of all state expenditures, an end to corrupt practices, and more funds to be spent on the poor. The king reacted by tightening restrictions and imposing heavier censorship. A report issued by a human rights group argued that Saudi citizens have fewer rights today than they had sixty years ago (i.e., before the discovery of oil in Saudi Arabia).

A study of the Saudi economy published in 1990 concluded that "[t]he real problem is that the country has, since 1973, locked itself into what appears to be an inflexible situation with very little room for manoeuvre. This bleak assessment was made before the Gulf War and the decision to double the armed forces and greatly increase purchases of costly military equipment. In its more colorful style, The Economist concluded in 1987 that Saudi Arabia's "budget has got into [a] great bind.... [The oil shocks] gave ... the Saudis extra purchasing power per head, greater than that of the U.S., and the Saudis employed a pack of planners to tell them how to spend it. Their plans now stand like Shelley's desert statue of Ozymandias.... Those billions of extra public spending have not increased by twopence-worth the Saudis' ability to earn a living in the harder times ahead, but have probably reduced it.

Between mid-1990 and mid-1993, Saudi contracts signed with the Pentagon totaled $30 billion. This is aside from large arms purchases from the British and others. An unnamed financial advisor to the Saudi government who reportedly has access to secret financial data stated in 1993:

1 don't think the U.S. government knows what it's doing by shoving weapons down the Saudis' throats. They're forgetting that what they are doing is creating instability in Saudi Arabia [by aggravating its fiscal problems]. That could be the greatest risk to Saudi security.