Why Saudi Arabia must modernise its social contract

ince 2014’s oil price collapse, the reliance of Saudi Arabia on oil revenues for both government capital and gross domestic product has been obvious for all to see.

Even with very high fiscal reserves, the government has sensibly commenced cutting its budgeted expenditure back, although it still had to draw down on its fiscal reserves by around 25 per cent. This has predicated a cut back in government grandiose in the public sector – where wages represent over 10 per cent of GDP and in some ministries more than 50 per cent of their budget – bringing about pay and benefit cuts from the top down.

What has been even more evident is the driver through Vision 2030 to enable the Saudi population to find employment in the private sector and so relieve the burden of expenditure on the government.

However, this requires the diversification of the kingdom’s economy, which has been so dependent on oil historically that its GDP dropped by 8 per cent from 2014 to 2015. Considering this, the critical importance of non-oil GDP growth becomes obvious.

Much like other Gulf states, Saudi Arabia has developed a social contract between the ruling family and its population as a whole. While the government is able to preside over the country and administer its mineral wealth, it must do so in a way that benefits the population.

Individuals and families in the kingdom have in recent generations become used to not having to pay market prices for petrol, water and electricity to name but a few subsidies, on top of well-paid government careers. In return the country’s rulers are allowed to govern and protect its citizens.

With the oil prices rising to over $110 per barrel, the expectation and indeed result was a huge expansion in expenditure as the government ploughed through the profits of oil sales into supporting subsidies, developing mega infrastructure schemes and ensuring the citizens of the nation were educated and happy.

However as a result of the government’s cutbacks in spending there now has to be significant change, or at least a painful pathway to modernisation of this social contract.

Throughout this period, Saudi Arabia’s population has been steadily increasing at over 3 per cent per annum to over 30 million. And with 2.8 births per couple on average, according to 2014 figures, the population continues to grow.

As of today, more than 50 per cent of the kingdom’s citizens are under the age of 30. All meaning the requirement for social infrastructure, power, water and associated services is growing steadily. This compounds issues such as the fact that Saudi Arabia is one of the most water-hungry consumers per capita in the world at over 300 litres per person per day. Coupled with the increasing need to generate employment opportunities for members of society, these requirements have placed pressure on the establishment to deliver.

Demand on infrastructure has started to reach a critical level brought on by capacity constraints, and with continued population growth expected over the coming years the situation will be compounded. For example, water demand is growing by 10 per cent per annum and electricity demand is expected to double by the time Vision 2030 is reached.

This subsequently requires significant development of new capacity right at the time when oil prices have fallen to a level that is creating a significant budget deficit and a lack of funding to deliver the required capacity. The deficit in 2016 is expected to be 13 per cent, an improvement on 2015’s 16 per cent.

With desalination supplying over 60 per cent of the water in the kingdom this growth is unsustainable, particularly with an increasing population. The water problem must be addressed immediately, and especially as desalinated water is so power intensive to produce.

The power and water sector represents over $350bn of a $1 trillion pipeline of projects in Saudi Arabia. Of this $350bn, $130bn is traditional power, $95bn is water and $125bn is nuclear and renewables. So a combination of energy and water efficiency and new programmes of development are necessary.

To caveat, while demand for infrastructure continues unabated at this time, one area of infrastructure likely to be delayed is the GCC rail network, of which the kingdom forms a significant part.

With the National Transformation Programme (NTP) being rolled out, based upon its stated aim of diversifying the economy away from oil, there is significant potential to promote private sector activity within these areas.

In this regard, the net benefits should be the employment of Saudi nationals to deliver these schemes, transferring employment pressure away from the government. However, while this should be a popular and potentially quite achievable aspiration in the major hubs, due to the size and diversity of Saudi Arabia, it is likely to prove much more challenging outside of major conurbations where the government is the majority employer.

Implementation of the Saudisation policy to encourage the private sector to increase the training and employment of nationals has become even more critical in light of the government cutting its 2016 budget by 15 per cent over 2015. And it will continue to make reductions to realign revenue and spending in 2017.

The IMF is forecasting a 9 per cent budget deficit in 2017 and subsequent job losses in government entities seem almost inevitable following salary reductions in the sector in 2016.

However, efforts to promote Saudisation have been significantly hampered in recent years by grandiose spending and jobs with favourable working hours and conditions in the public sector.

Given the impact on the social contract, the shift from public to private sector employment has the potential to shake up the accepted norm throughout the conservative nation.
The tacit reality is that the development of infrastructure to support a growing and young population, the engagement of the private sector and drive to move Saudi’s from government to private sector jobs is critical if the kingdom is to achieve its aspirations to diversify its economy away from oil.

It’s the pace of change that may need to be managed more carefully. Previous generations, known for being conservatives, are likely to resist and that could undermine the intent of the diversification. The private sector needs to be engaged and incentivised with transparency and fairness to harness the potential that lies within and at least partially meet the expectations of the kingdom and its nationals and residents.

As a $43bn per annum contributor to GDP, the construction sector has an important role to play in promoting Saudisation, diversifying the economy and enabling reduced reliance on oil in the economy – but how? One potential opportunity is to move towards alternative financing models to encourage whole-life private sector engagement. These are currently under development in the kingdom and various formats have been tried and partially tested in a limited capacity previously.

However, to engage Saudis and develop capacity in the country, more is required. Construction organisations need to engage with educational establishments and they in turn need to become a focal point for breeding the required work ethics and skills that are in demand in the industry and encouraging students down the STEM career route.

With the increasing youthfulness of the population, a once in a lifetime opportunity presents itself; to change the engagement model from secondary school onwards and for the industry to adopt models applied successfully in other parts of the world. This includes apprenticeships, internships, work experience and graduate schemes that foster and develop nationals and allow diversification to occur.

This will allow the private sector to be successful, the government to fulfil its social contract in regards to employment, and for capacity to be built for future citizens.

A generational change is needed and a government commitment to not revert to its previous behaviours.

David Clifton is regional development director at Faithful + Gould