V. THE VIABILITY OF SAUDI INDUSTRY

From its inception, the heart of Saudi Arabia's economic diversification program has been the industrial sector. The goal has been to increase non-oil exports and to provide locally-produced substitutes for imported goods, thereby reducing the country's overwhelming dependence on oil exports. As the deputy minister of commerce phrased it in 1986, "[i]ndustry is now the backbone of [Saudi] development.

The focus of Saudi industrial efforts in the 1970s was the construction of a mammoth gas-gathering system utilizing the natural gas associated with the extraction of crude oil, which, for the most part, had simply been burned off. According to Saudi planners, this previously-wasted source of energy would be used to generate electric power and provide raw materials for world-scale petrochemical plants that were to be built in two newly-planned industrial centers, Jubail on the east coast and Yanbu on the west coast. Other manufacturing would also be developed in these centers, based largely on the raw materials to be produced in the petrochemical plants. ARAMCO was named the major contractor for the gas-gathering project, whose final cost amounted to about four times the original scheduled budget of $5.5 billion, despite a large cutback in its scope.

As for the planned petrochemical plants, the Saudis anxiously courted multinational firms to enter into partnership with the Saudi Arabian Basic Industries Company (SABIC), a newly established state-owned industrial combine. In the flush days of the 1970s and early 1980s, they were not seeking outside financing. Rather, the Saudis were interested in partnerships in order to acquire the managerial and technical know-how and marketing channels of the multinationals. To that end, the Saudis offered loans on very favorable terms to finance most of their prospective partners' share of investment in the proposed joint ventures. Additional inducements included cheap feed stocks, land, water, electricity, and other inputs at highly subsidized prices.

Despite the inducements, however, foreign firms shied away from these ventures. They apparently felt that the outlook for profitability was poor, regardless of how much the Saudi government was willing to pump into the project. In 1978, the British Quarterly Economic Review, which surveyed already-established Saudi industries, arrived at very pessimistic conclusions:

Many of the industrial projects, both large and small, are not [internationally] competitive.... Most of the heavy industry now operating has been disastrous, and there is little reason to suppose that the [planned] new industries will be different. . . . The implications for the country's future are obviously momentous.

Frustrated by the reticence of multinational firms to accept their offer, Saudi authorities did not take kindly to this criticism. The minister of industry dismissed as "wicked" those who questioned the government's industrialization plans. In January 1979, he declared: "We shall go on implementing all our industrial projects in jubail and Yanbu with international partners-if the international partners so wish-and without partners if they . . . hesitate. . . We are not ready to remain mere [producers] of raw materials [i.e., crude oil] forever." But despite the brave talk, the Saudis knew full well that they lacked the managerial and technical know-how to operate such industries

The second oil shock and the almost unanimous forecasts of future oil shortages and higher prices afforded the Saudis an opportunity to persuade foreign partners to enter into joint ventures. In the early 1980s, the "security" of oil supplies was a major concern of international oil companies and Western governments. What could be more secure than access to Saudi Arabia's vast oil reserves? Moreover, as noted earlier, while all other producers were raising their prices, the Saudis did not exact surcharges and premiums over and above officially-declared OPEC prices. Instead, the Saudis guaranteed any firm entering into a petrochemical or other venture a long-term supply of oil with the quantity based on the size of the investment. A number of companies calculated that even if there was little prospect of profitability from the joint industrial ventures, they would be compensated for their investment by the assurance of oil supplies at favorable prices. As a result, Shell, Mobil, Exxon, Mitsubishi, Celanese, and Texas Eastern were among the major firms entering into joint ventures with SABIC in the early 1980s. The softening of oil prices and the OPEC agreement of October 1981 eliminated the Saudi price advantage and completely altered the picture. In subsequent years, other countries offered discounts and purchasers of Saudi oil found themselves at a distinct disadvantage. As a result, Dow Chemical withdrew from its agreement with SABIC in December 1982, while others requested revisions.

In addition to crude oil sales, the exportation of refined oil products was viewed as an important element in the drive to diversify the economy. Refinery capacity had been expanding rapidly in the 1970s, but so had domestic oil consumption. The rapid growth in local demand was a function of both the growth of the economy and the absurdly low internal prices for oil products and electric power. Domestic oil consumption escalated from 57,000 barrels per day in 1972 to 823,000 barrels per day in 1984, a phenomenal average annual growth rate of 20 percent. Refining capacity was expanded but exports of refined oil products remained at about 500,000 barrels per day during the 1970s and the first half of the 1980s. In the early 1980s, a number of joint ventures with Petromin (a state-owned oil company) were concluded for the construction and operation of oil refineries designed specifically for export. During the second half of the 1980s, domestic oil consumption was more or less stable at 700,000-800,000 barrels per day, largely reflecting the impact of the recession. The completion of the new refineries raised exports of refined oil products from about 500,000 barrels per day in the 1970s and the first half of the 1980s to about 1 mbd in the latter half of the 1980s, but the bulk of Saudi oil production continued to be exported as crude, unlike some of its rivals in OPEC that export mainly refined oil products. In addition, Saudi Arabia negotiated a number of joint ventures fertilizers, iron and steel, aluminum, and other industries.

Overall, government policy dictated that heavy industry would be the province of the public sector, preferably in partnership with multinational firms. In contrast, light industry, geared mainly to produce for the domestic market, would be undertaken by the local private sector, which would be provided with a wide range of incentives. These included financing of up to 50 percent of a project by interest-free loans of up to fifteen years; exemption from duties for imported equipment, raw materials and spare parts; the provision of land for a factory or space in a state-built industrial estate at nominal rents; water and electricity at very low rates; preferential treatment in government purchases; tariff protection up to 20 percent on competing imports; grants for training Saudis; and other subsidies. Under a regulation issued in 1983, foreign firms awarded government contracts were required to subcontract at least 30 percent of the value of a contract to local firms. The government also offered a wide range of incentives for foreign private investment in light industry, but foreigners have found few areas of profitable investments

Under the stimulus of the various incentives there has been considerable investment in manufacturing, particularly petrochemicals, other heavy industry, oil refining, and in construction-related products. In the early 1990s, it was estimated that total investment in industry was £13.4 billion (approximately $24.4 billion), of which about two-thirds came from SABIC (mainly petrochemicals) and Petromin (oil refining) and the balance largely in a wide range of light industries. Measured in terms of value-added (in constant prices), manufacturing (excluding oil refining) expanded rapidly by an average annual rate of 14 percent between 1975 and 1985, and then stagnated around the 1985 level until the end of the decade. The very sharp drop in construction that began in F'YI982 was the major factor retarding further growth in manufacturing during the second half of the 1980s. Much of the industry was geared to providing construction materials, and the sharp decline in construction was a direct result of the cutbacks in the projects budget.

In 1987, the minister of industry reported that there were about 2,000 factories in the kingdom with a total investment of $16 billion, producing about 15 percent of the manufactured goods consumed in Saudi Arabia. He stated that value-added per capita in manufacturing exceeded that of South Korea. The undersecretary of the ministry of industry projected that by the early 1990s, value added in per capita Saudi manufacturing would rise by two-thirds. Comparing Saudi and Korean manufacturing was and is ludicrous. South Korea is light years ahead in terms of qualified management and a trained labor force. South Korean industrial production doubled between 1985 and 1991, while in Saudi Arabia value-added in manufacturing rose by 11 percent, implying a strong decline on a per capita basis.

The dearth of high-level Saudi manpower, defined in its broadest context to include managers, technicians, and skilled personnel, is the major obstacle to Saudi economic development in general and to its industrial plans in particular. The government has long recognized the problem and has taken various measures to train a domestic labor force that can meet the challenges of a modern economy, but so far it has met with little success. The government budget sets aside large sums for education on all levels, with special provision and incentives for enrollment in vocational education. But it appears that, aside from the Shi'a, who suffer from discrimination and are mostly barred from white-collar government positions (and the armed forces), Saudi nationals shy away from occupations that involve manual labor, skilled or unskilled.

By and large, industry (as well as construction, agriculture, and some other sectors) relies heavily on foreign managers and technicians, and expatriates perform a very large share of the skilled and unskilled labor. In 1982, a Saudi economist observed that "[i]t is not unusual for an industrial plant to have not a single Arabic-speaking (Saudi or other Arab) individual, for the managers are usually Europeans and the workers are almost certain to be from the Indian subcontinent and from the Far East." In this regard little change took place during the 1980s. A 1992 study noted that there is "a striking absence of Saudi labor" in manufacturing.

The authorities have tried to cope with this problem by issuing orders to the larger firms to hire and train Saudi nationals. But the managers complain that few Saudis are willing to enter into an training program and that the costs of training are prohibitive. One American economist, a longtime student of the Saudi economy, suggests that the reluctance of the Saudis stems from the "availability of foreign skilled and unskilled labor.... For a variety of economic and social reasons, Saudi workers have been slow to move into . . . occupations opened up in the newly developed industries. The government has contributed to this problem by creating a large number of low-productivity public sector jobs" (i.e., a bloated, unproductive bureaucracy).

"Saudization" is a theme often stressed by government authorities, but the obstacles are formidable. As another American economist and longtime student of the Saudi economy concluded in 1986:

In industry, Saudi Arabia will be dependent on foreign workers indefinitely for the same reasons this Kingdom has been dependent in the past. First, Saudis will resist doing certain types of work, and will not accept the lower incomes associated with many types of employment within industry. Second.... the mixture of skills and experience required by heavy industry will not be available in the Saudi labor force for decades. A 1987 report in The Middle East reached rather pessimistic conclusions:

Saudi officials [are fearful] that the transfer of technology and skills is not going to reach Saudi nationals.... It increasingly looks as if Western joint venture entrepreneurs are going to have to (continue to] provide their own experienced manpower not just to train Saudis but also to run the sophisticated infrastructure ... for years to come.... The big question is whether there are enough Saudis interested in learning the requisite skills.... Western companies in Saudi Arabia must not only supply the skilled manpower to set up the projects but be prepared to operate them for years to come.

A 1987 study of economic development in the Arabian peninsula, where Saudi Arabia is the dominant economy, noted that the percentage of students in secondary education enrolled in technical or vocational schools was abysmally low, ranging from just 1.5 to 3.6 percent. The report notes that these countries consider industrialization as the key to development . . . yet their educational systems and institutions and social attitudes are inconsistent with the demands . . . of . . . industry. . . . Those who enter the vocational track are the failures of the general [academic] track. . . . [T]he association of the vocational track with failure reinforces the disdainful attitude towards vocational training. Nearly one-half of the graduates of all Saudi universities [specialize in] Arabic [literature] and Shari'a [Muslim religious] law. The director of King Saud University noted that 70 percent of the graduates held degrees in what he called "non-technical" fields.

In assessing the viability of Saudi industry, it is important to distinguish between private and social profitability. If an industry receives massive subsidies on a continuing basis, the firm or firms in that industry may be privately profitable, but they constitute a serious drain on the economy. As more and more petrochemical plants came into operation, SABIC's output expanded rapidly. In 1988 it announced profits of nearly $1 billion. Despite increased production and sales, however, profits steadily declined over the next four years. Indeed, in 1992 they were about half the 1988 level.4 Much of this was due to a world-wide glut in petrochemicals. But even in the more profitable years, the returns were very meager in relation to invested capital. As one recent study that appeared in the Gulf States Newsletter concluded, the profits made by SABIC and other large industries "are made possible only by the wide and generous range of government subsidies. Nonetheless, SABIC is continuing to expand capacity.

More recent studies confirm the pessimistic assessment of Saudi industry and its future prospects made in 1978: "Without financial transfers [from the government] at least two-thirds of . . . manufacturing industries would die if they had to pay for locally produced inputs (e.g., electricity, gas, and water) at actual production cost, and make proper independent provisions for a proper return on invested capital. A British economic journal, the Economist Intelligence Unit, concluded in 1991 that, " [t] he development of self-sustaining private sector activity is proving an elusive objective given the small size of the local market and the dependence of companies in the private sector on government contracts and subsidies. And, as an independent observer noted, "[tlhe Saudis are learning the hard way that money alone cannot industrialize a country. Infrastructure, qualified manpower, an efficient bureaucracy, and the correct national attitude toward a whole spectrum of work are but a few of the prerequisites."